Thursday, December 19th, 2024
What the Internet has created is a nation of entrepreneurs, especially in the United States. There are now literally millions of self-employed individuals, pursuing their dream business. This is due to a shifting economy, layoffs, downsizing and the current health crisis.
The new stream of revenue and the freedom is great, but many do not enjoy the paperwork and confusing tax issues which arises from owning their own business.
Most self-employed individuals are classified as “sole proprietors” or “independent contractors,” when it comes to tax purposes by the IRS.
This is true regardless whether you are turning a hobby into revenue, selling the proverbial “widget” into cash, or providing services to others.
As a self-employed person, what you’re required is to report your business revenue or loss results, on your personal income tax return.
There are a few guidelines along with issues you should keep in mind, if you’re wanting to pursue your entrepreneurial spirit.
What Is A Schedule C – Form 1040
As a self-employed individual, you’re required to report your small or home business profits or losses on Schedule C of Form 1040.
The business income earned is taxable to you as an individual. This applies even if you don’t withdraw any money from the business.
You are required to report your entire gross revenue, while allowed to deduct business expenses incurred in generating that revenue.
If your business efforts happens to result in a loss, the loss is generally deductible against your total income from all sources.
This however is subject to special rules which relates to whether your business is considered a hobby, and whether you have anything “at risk.”
Definition Of A Home-Based Business
If you are self-employed and work out of your home, you are entitled to deduct a certain percentage of costs and expenses which are applicable to the portion of the home used as your office.
Some of these expenses and costs can include utilities, telephone, Internet services, etc.
You are also eligible to claim these deductions, if performing administrative tasks from your home or if you store inventory there.
If you work out of your home while having another office at another location, you may also deduct commuting expenses between the two locations, as transportation expenses.
What most self-employed individuals find, is usually working more than the usual 40-hour week. There may be other deductions you can claim as a result.
What the majority of self-employed individuals are not aware of however are these deductions, and why a tax advisor may come in handy.
Self-Employment Taxes
One negative aspect some consider to being self-employed, is the need to claim self-employment tax.
If there are salaried individuals, they are subject to automatic deductions such as FICA, etc. deducted from their paycheck.
Most self-employed individuals often don’t use a formal payroll for themselves, so the IRS recaptures these taxes through self-employment tax.
What this means is you’re required to pay self-employment tax of 15.3% on the first $142,800 worth of net income (2021).
The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
Health Insurance Premiums
If you happen to be self-employed, then you may be eligible to deduct for certain health insurance premiums you’ve paid for during the year.
This includes all medical, dental and long-term care insurance coverage that qualifies, for yourself, your spouse and your dependents.
How To Calculate Self-employment Tax
The amount which is subject to self-employment tax is 92.35% of your net earnings, from all self-employment income.
You can calculate net earnings by subtracting all of your “ordinary” along with all necessary trade and/or business expenses from the gross income, you derived from your business.
Record Keeping For Your Small Business
What’s required is you need to keep complete record of all your business activities. This include receipts of all your business income and expenses.
What you need to do, especially when in doubt, is to document everything related to income and money spent.
Begin by creating a filing system for each month you’re in business, and file every receipt, etc. appropriately.
All of your business travel expenses needs to be properly documented, which includes mileage from your car, when performing business tasks.
The rule of thumb is, if you have any issues or doubt when it comes to documenting something, just record it and file all the receipts.
The Need For Tax Advice
When you’re a self-employed individual, what your main focus and time should be spent on is making your business profitable.
Your focus should not be on the various complexities of the Internal Revenue Service tax code, or how to limit or maximize the amount of taxes you owe.
If your business is new, then it’s highly likely you may be paying more tax than you should, because of certain loopholes and advantages of being self-employed.
The best advice especially once you start generating income, or are currently not making money, is to seek out advice from a tax expert to save time, and to keep Uncle Sam off your back.