Of course you can read about all this information regarding small business and taxes from the IRS. You just need to drink a gallon of coffee before you start. I’ll try and simplify things and explain them in a way that is easy to understand.
This will be my seventh year to file as a self-employed individual. To be perfectly honest, self employment tax information is never fun, but when you know what to expect and make small preparations all year round, the tax filing season can be simplified to the point that you no longer feel like bashing your head against the computer.
This post includes introductory tax information for small business owners and entrepreneurs who are just learning about the tax implications. This should not be considered legal advice, and you should verify the accuracy of the information in this post.
Now that I’ve washed my hands, I’ll continue.
Who Must Pay Self-Employment Tax?
If you are a small business owner based in the United States, you will be required to report your income earned on your taxes. A small business owner is not just someone who has a Professional LLC or official business. You can be a sole proprietor (not part of a corporation) and be required to pay self-employment taxes. You don’t need to officially be a business owner, but any regular person who makes extra money.
Here’s the official list from the IRS:
You carry on a trade or business as a sole proprietor or an independent contractor.
You are a member of a partnership that carries on a trade or business.
You are otherwise in business for yourself.
This includes anyone who:
- A teen who has a summer business
- A freelancer
- A blogger who makes money
- A person who sells cakes from home
- A person who makes money selling on ebay
I think you get the point. If you made money outside of your day job, you will be required to pay taxes (that doesn’t surprise you, does it?).
If your net earnings from self-employment (excluding church employee income ) were $400 or more or you had church employee income of $108.28 or more then you will need to pay self-employment tax.
If you have been paid more than $600 in the year by any one source, you should receive a 1099. A 1099 reports how much income you earned in the year. Still, even if you did not get a 1099, your income earned through your small business is always taxable.
Also, the inverse is also true. If you paid someone more than $600 for services you must issue a 1099.
When I do taxes with Turbo Tax (Home and Business), I enter income earned where I received a 1099-MISC, where I didn’t receive a 1099, and any other random sources of income. Every source of income must be recorded and reported.
What Deductions Are Available for the Self Employed?
The best tip for any small business owner is to take time between January 1st and 15th (arbitrary dates) to review all eligible deductions. The reason is simply that your purchases and bookkeeping should always be made in light of the tax consideration.
Here are the general categories that you can deduct:
- Home Office
- Asset Depreciation
- Taxes and Licenses
- Business Travel
- Meals and Entertainment
- Insurance Payments
- Interest Payments
- Rental Payments
- Legal and Professional Fees
- Contract Labor
- Repairs and maintenance
- Utilities for business
- Office expenses
As you can see, that is quite a list. Time (along with my own sanity) won’t allow us to go into detail on all these categories, but I’ll make a few general comments that apply to or might surprise first time small business owners.
If you use a vehicle for business and personal use, you must record your mileage.
I think this is a category that is often under reported. The reason is that people are unorganized and prioritize all the pressing things of life. If you do not own a business vehicle, you will need to have a notebook in your car. In that notebook, record the date of the trip, the destination, the purpose, the start mileage, the finish mileage, and the total mileage.
Any time you get into the car for a business related trip, record it!
If you do your business from home, you’ll want to keep detailed personal records on the costs associated with your home expenses. This includes things like gas, electric, water, and trash removal. The reason is that you’ll be able to deduct a portion of your home expenses according to the size of your home office.
If you don’t keep a personal budget, you might consider starting, if for no other reason than to make your business tax filing simpler.
Meals and Entertainment Expenses:
Your business related meals break down into two categories:
- Meals and Entertainment for business associates while traveling and while entertaining are only deductible up to 50%. Therefore, if you take a client to lunch and the bill is $50, you can only deduct $25. Want to know how to keep track of everything? You got it – keep detailed records.
- Meals and Entertainment for charity events and company parties can be deducted at 100%.
If your business shows a profit, you can deduct the cost of your health insurance. This is only a possibility if you don’t deduct it elsewhere (i.e. if you are an employee and it is withheld from your employee salary).
Certain portions of your long term care insurance is deductible along with any business related insurance.
When Are Self Employment Tax Payments Due?
Unfortunately, I think this is one area that confuses first time business owners. Some decide to keep aside money for taxes till the end of the year when they file. This is actually a mistake.
When you are self-employed, you must make quarterly tax payments.
In general (unless the 15th is a weekend), those payments are due:
- April 15th
- June 15th
- September 15th
- January 15
Even though I missed a scheduled quarterly payment this year, I’ll proceed to show you how not to do that.
- At the start of every year put a reminder into your favorite calendar system. Tell it to notify you on April 1st, June 1st, September 1st, and December 26th.
- Set up an account using the Electronic Federal Tax Payment System. If your self employment income is quite regular, you can even schedule your payments for the entire year. If you do this, you’ll still want the reminders to be sure that you have enough money in your account to cover the withdrawal. I use the online system because of simplicity, and also I love the paper trail. Since I get a transaction ID, I don’t need to worry if my check got lost in the mail.
What if you haven’t been making quarterly payments? As soon as possible (prior to January 15th, if at all possible), go ahead and calculate your taxes due and pay them. While you might pay some interest, you’ll at least have your taxes paid in full by the final quarterly payment due date.
In case you need some extra help, here a post on how to calculate self employment taxes.
Helpful Self Employment Tax Information and Tax Tips
Tip #1: Always keep detailed records.
While this is true even if you are not self-employed, it is even more important if you are. The reason simply is that you are more likely to:
- Have accurate records (and proof) in case you are audited and your income is questioned.
- You are less likely to miss a deduction.
Remember, this is a stitch in time saves nine sort of thing. You’ll eventually need to account for everything, so make it easy on yourself by doing it as you go along.
Tip #2: Determine how you will file taxes at the start of a year and use an accounting system that is consistent with that method.
For example, I use TurboTax to file my tax returns. I’ve done that for the last nine years. As such, this year I’ll start using either Outright or Quickbooks that allows me to easily track all of my income and expenses. This year I made the mistake of tracking my expenses in Excel. While that was a simple process, it is going to make tax season a BEAR.
Tip #3: Get a business credit card or use a debit card.
Look, I know everyone is not a fan of credit cards, but I must say that I’d pay a premium to use a credit card just for the accounting value. If you’re not a fan of credit cards, consider getting a debit card. Having a second physical record of all your expenses is so much easier to track than having a stack of cash receipts. Also, with credit cards it is really easy to download transactions into your account program.
Tip #4: Your first year operating as a self employed person, you might want to consider having a tax professional review your information.
This way you make sure you’re not missing any deductions. However, once you’ve done it once to establish the pattern, you should be able to do it yourself (unless you’d rather just pay someone else to do it). I prefer to be involved in my own taxes because it makes me more cognizant of expenses as I go along. Like I mentioned in this post, I’ve always used Turbo Tax Home and Business.
Tip #5: Get a business bank account.
The more you separate business and personal expenses, the easier it will be to manage both your personal and your business finances, as well as taxes.
Photo by JD Hancock
What tax tips or advice do you have for someone who is just getting started?