A Complete Tax Preparation Guide for Self Employed

Over the last decade or so the self-employment industry has grown rapidly and come a long way. The growth rate of this industry is more than any other employment segment. This employment sector has created a huge number of income opportunities for individuals and makes a way for their financial freedom. But with freedom comes responsibility. And the responsibility is to manage your income, expenses and file your own taxes. But the process of tax preparation for a self-employed individual is different from personal tax preparation. So it’s better to know the process so that you can avoid any trouble.

Who is self-employed?

Sometimes people find it difficult to differentiate between self-employed individual and traditional job employee. If any person works for himself instead of working for a company and earns his income is called self-employed. If any of the following conditions apply to you then you are a self-employed individual.

  • You ran a trade or business as a sole proprietor or an independent contractor.
  • If you are a member of a partnership business.
  • Or you have a part-time business in addition to your regular job.

Tax obligations of self-employed individual

Under the category of self-employed individual, generally, a person is required to file an annual tax return and pay estimated tax quarterly. As a self-employed individual, you have to pay a self-employment tax (SE tax) as well as an income tax. The SE tax is a social security and a Medicare tax. And it is different from income tax.

Before you can identify your tax obligations, you have to figure out your net profit or net loss from your business. You can calculate your profit or loss very easily. What you have to do is subtracting business expenses from your business income. If your business expenses are less than your income then the difference is a net profit and it’s a part of your income. On the other hand, if your business expenses are more than your business income then the difference is a net loss. You can always deduct your loss from your gross income since in some circumstances your loss is limited.

Not every self-employed individual has to file an income tax return. If your net earnings from self-employment were $400 or more then you have to file an income tax return. In some special condition (Form 1040 Filing Requirement) you may have to pay income tax regardless of your income is more or less than $400. You also have to file income tax if you are eligible for any of the following credits:

  • Credit for federal tax on fuels
  • Premium tax credit
  • Health coverage tax credit
  • Earned income credit
  • Additional child tax credit
  • American opportunity credit

According to IRS, self-employed taxpayers who might owe more than $1,000 in SE taxes have to make estimated tax payments four times a year. You have to use IRS Form 1040 to file the quarterly taxes.

Preparing self-employed quarterly taxes

Estimated tax is a method of paying tax on income that is not subject to any type of withholding, which includes self-employment income. As I have stated before you have to pay estimated tax four times a year. Moreover, you have to use “Form 1040-ES, Estimated Tax for Individuals” for tax payment. Form 1040-ES is very much similar to Form 1040. Note that you will need your previous year’s annual tax return in order to fill out Form 1040-ES. So make sure that you keep track of your income tax return from one year to the next year.

The form 1040-ES contains blank vouchers. You can use these blank vouchers when you mail your estimated tax payments. Or you may make your payments using the Electronic Federal Tax Payment System (EFTPS). If this is your 1st year as self-employed, then you have to estimate the amount of income you expect to earn for the year. If your estimated earnings are too high then you can complete another Form 1040-ES worksheet to refigure your estimated tax for the next quarter. Similarly, if your estimated earnings are too low then you can complete Form 1040-ES worksheet to recalculate your estimated taxes for the next quarter.

Self-employed year-end tax preparation

If you want to file your year-end tax returns then you have to report your profit or loss from a business that you operated. Or from a profession, you practiced as a solitary proprietor. You have to use Schedule C or Schedule C-EZ for reporting. A Self-employed individual with expenses of $5,000 or less may be able to file Schedule C-EZ instead of Schedule C. To help you out, there are instructions on the Schedule C-EZ form. So you don’t have to worry about it.

While filing your annual income tax you have to calculate your final taxes for the prior year. If you paid more taxes then required in quarterly tax payments, you’ll get a refund. On the other hand, if you paid less tax then required in quarterly tax payments, you owe more money to the government.

Tips to save on taxes

If you are a first-time self-employed taxpayer then you can follow these tips to save on taxes.

The tips are:

Startup costs: If your business is newly formed then you can deduct startup costs, including legal fees, the cost of advertisements.

Vehicle expenses: Apart from the mileage deduction and other expenses, a self-employed individual may be able to deduct up to $25,000 of the cost of their car or SUV.

Home office deduction: Another great way to save on taxes for a self-employed individual. If any self-employed worker uses a dedicated space in their home for business purpose then he can deduct a percentage of his home expenses from tax, including mortgage payments, utilities, and property taxes.

Supplies and equipment: You can deduct office supplies and equipment from tax if they were used exclusively for business. For example expenses on paper, computer etc.

Health insurance premiums: As a self-employed individual you can/may deduct what you pay for medical insurance for yourself and your family.

Conclusion

Preparing tax is not an easy task, but now that you have more knowledge about tax preparation for self-employed individual, you can easily prepare your tax if you are a self-employed. Moreover, this self-employment tax guide will ensure that you don’t have to pay additional fees or penalties for underpaying your taxes. Finally, the key to successful tax preparation is to keep track of your expenses all year round. And of course to submit your income tax before the deadline.

Abdul Quddeus
Abdul Quddeus is a CPA, CGA, and founder of MAQ CPA Professional Corporation. He helps small business owners, professionals and individuals save their hard-earned money on taxes and let them free up their time to concentrate more on core business by providing tax planning and compliance, bookkeeping and accounting services.
Abdul Quddeus

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