5 Tax Tips for the Soon-to-Be Self-Employed
One of the best decisions many people made during the pandemic was to spin out on their own as self-employed independent contractors. They found that working from home was rewarding in more ways than just financially. Some simply realized that they did not want to return to the daily grind of employment or the office/shop environment. Still others had been thinking of the jump to self-employment for a long time and the pandemic was the final nudge.
You may be ahead of the game when it comes to self-employment and taxation of income, but just in case you would like some getting started tips, let these 5 tips help you get your business up and running.
- It’s not just income tax now – self-employment taxes are due.
You will not only pay income taxes on your business profits, but you will also pay self-employment taxes as well. In 2021, the rates were 15.3%. That is 12.4% for social security and 2.9% for Medicarei for the first $142,800 in profits or wages you pay yourself.
As an employee, you would have had half of that amount withheld from your wages. As the owner and self-employed, you are liable for the entire amount. After the first year of operation, you will probably be liable for quarterly estimated payments for self-employment taxes. You would pay ¼ of last year’s taxes each quarter as a minimum to avoid penalties. If you owe more, you will pay the IRS when you file your return.
- Organize your bookkeeping.
Organization of how you keep track of income and expenses is important for several reasons, including:
- You want to make it easy and efficient so that you do not have to spend a lot of time and effort in recording income and expenses. It is important, but you want to spend your time operating your business as a priority.
- An organized system and records will make it easier for your accountant or tax preparer to prepare your return with accuracy.
- Should the IRS have questions, they look much harder at your business if they perceive a disorganized system for bookkeeping, as they expect to find errors.
- Organized records help you to analyze the performance of your business to help you when making decisions.
Financial record-keeping is a necessary evil in the eyes of many business owners, but it is crucial.
- Be sure to report all your income.
Whether you receive a Form 1099 from clients or customers, you are required to report all income to the IRS with your tax return. Businesses are not required to provide a 1099 to independent contractors that are paid less than $600 during the tax year, and some other corporations are not required to report at all. This does not relieve you of the responsibility of reporting that income, however.
- Avoid the “hobby loss” trap.
The IRS is vigilant about watching self-employed individuals, particularly those who also have a regular job as well. They do not like seeing losses from their self-employment offsetting other income for taxes. If your business shows losses more than two years out of five, you could come under scrutiny and the IRS may classify it as a hobby rather than a business.
- Lawfully maximize deductions to minimize taxes.
You save self-employment and income taxes on every dollar of legitimate deductions. The word “legitimate” is key. The rules for deductions, particularly for things like travel and entertainment, can be complicated. Mistakes in these areas can get you the dreaded audit notice. It is best to consult with tax advisory services when there is any doubt about the legality of deductions.
Self-employment is a path to asset-building and a comfortable retirement, but only if you do it right. Learn the rules and look forward to success.