Anyone who starts their own business eventually needs to learn how to file taxes as a self-employed worker. The alternative, not filing taxes and seeing your back taxes bill balloon over the years, isn’t pretty. We’ll start with the self-employment tax first, because it’s so important, and then we’ll start looking at some of the other things that self-employed people need to know about filing taxes.
What Is Self-Employment Tax?
Self-employment tax is a tax made up of Social Security and Medicare taxes. If you work for yourself, you pay this self-employment tax in lieu of having a company withhold Social Security and Medicare taxes from your paycheck.
The self-employment tax rate is 15.3%, and it breaks down into the two aforementioned parts: 12.4% for Social Security and 2.9% for Medicare. Self-employed individuals pay the 12.4% on the first $147,000 of their net income in 2022 — and 2.9% for Medicare on all of their net income, whether a taxpayer makes $142,800 or $1.42 million or more.
If that seems like an eye-popping amount of self-employment tax, keep in mind that if you work for a company and have Social Security tax withheld, your employer is paying a portion of that tax on your behalf. Because you’re the employer and employee as a self-employed person, you’re paying both portions of the Social Security tax and both portions of the Medicare tax.
Who Pays Self-Employment Tax?
Anyone who considers themselves self-employed pays a self-employment tax. As the Internal Revenue Service puts it, you are self-employed if:
— 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 business.
— You are otherwise in business for yourself (including a part-time business).
You may also need to pay a self-employment tax if you earned more than $400 working for yourself. The IRS says you have to file an income tax return if your net earnings from self-employment were $400 or more. However, if your net earnings from self-employment were less than $400, you can skip paying self-employment taxes on that amount even though you must still report those earnings.
Receiving 1099 forms is another clue that you may need to pay a self-employment tax. Employees receive a W-2 form and use the information on that to report the income to the IRS. If you’re working for yourself, in a full-time or part-time capacity, you’ll receive 1099 forms (either a Form 1099-MISC or 1099-K) from the companies or individuals paying you.
[READ: What Happens if You Don’t Pay Your Taxes?]
If You’re Self-Employed, Are You Required to Pay Quarterly Estimated Taxes?
Self-employed individuals may need to pay quarterly estimated taxes. The IRS website states, “As a self-employed individual, generally you are required to file an annual return and pay estimated tax quarterly.”
However, there are some exceptions. If you believe you’ll make less than $1,000 in a given year through your self-employment, you don’t have to pay quarterly estimated taxes. This may be the case if you’re working for yourself in a part-time capacity that isn’t yet bringing in significant earnings.
Failing to make quarterly estimated payments can result in a penalty for underpayment when you file your tax return. In addition, if you wait until you file your taxes in April, you may have a hefty tax bill and possibly one that you can’t pay all at once. So it’s smart to stay on top of things and make those estimated payments.
For most states, this year, those estimated payments will be made on April 18, June 15 and Sept. 15 and Jan. 16, 2024, based on your profits for that quarter. Individuals also have the option to sign up for and use the Electronic Federal Tax Payment System and pay taxes monthly if that’s easier.
How to File Self-Employment Taxes
To file your taxes with the IRS by April 18, 2023, you’ll want to take the following steps:
— Decide how the taxes will be prepared. Are you going to hire a tax professional? Purchase some tax preparation software and do them yourself? Or will you go old school and prepare them on your own online, or really old school with a tax form, where you’ll mail it in?
— Collect the necessary paperwork to file your taxes.
— File your taxes or send them to a professional.
— Plan for next year’s self-employment taxes by deciding how much your estimated taxes will be over the next year.
[How to Adjust Your Tax Withholding]
Decide Whether to Hire a Tax Professional
There are good arguments for hiring an expert rather than filing self-employment taxes on your own.
When you are working for yourself, there are a host of self-employment tax deductions to take advantage of, and knowing what you can and can’t deduct can get complicated.
A tax professional may save you money and keep you from overpaying your taxes — or underpaying, which can end up costing you in back taxes.
“If one is self-employed there are many matters that complicate their taxes. I always suggest working with a professional tax preparer to navigate the process and the uniqueness of their tax situation,” says Mitchell Franklin, associate professor of accounting at Le Moyne College’s Madden School of Business in Syracuse, New York.
Franklin says that there are so many factors you’ll want to consider, all of which a tax preparer will be familiar with.
“Common issues to keep in mind are the ability to use the home office deduction, the deductibility of health insurance premiums, car mileage, proper classification of business expenses versus personal expenses, and retirement savings in a tax-deferred self-employed retirement plan,” Franklin says.
The cost to hire a tax professional varies. A 2020-2021 survey report from the National Society of Accountants, which has not released an updated survey, solicited 1,009 NSA members and associate members, and found that a typical firm charges an average of $220 for a tax professional to prepare a Form 1040 and state return with no itemized deductions. Given that a self-employed person’s taxes will often be more complex than average, your cost will probably be higher. For instance, if you have an S Corp, you’ll pay an average of $903, according to the report.
[Read: How to Find the Best Tax Professional.]
Collect Your Paperwork
If you decide to file self-employment taxes yourself (or are gathering paperwork for your accountant), you’ll need the following forms:
— Form 1040, also known as your U.S. individual income tax return.
— Schedule C, which has your profit or loss from your business.
— Schedule F if you’re a farmer.
— Schedule SE, which helps you calculate your self-employment tax.
— 1099 forms. You may only have one, if you have one client, or you may have numerous 1099s (which should all arrive through the mail by early February). You’ll either receive one or several 1099-NEC and perhaps a 1099-K.
— You may be accustomed to receiving 1099-MISC forms, but those days are probably over. The MISC stood for miscellaneous income; the NEC is an abbreviation for nonemployee compensation. But if your business received certain monetary funds, like a legal settlement or prize money from a company, you may receive a 1099-MISC.
— A 1099-K, which you should receive in the mail if you use a service that processes credit or debit card transactions — and if it has processed at least $20,000 worth of payments and at least 200 transactions for you in the previous year. (That said, some PSEs — payment settlement entities — will send 1099-Ks no matter how many payments it processed for you.)
Lisa Greene-Lewis, a certified public accountant and TurboTax spokesperson, says that even if you don’t receive 1099s, “it’s important to keep careful records and track all income under these limits, as you still need to report all income regardless of whether or not you received the forms.”
There may be a lot to collect, depending on your company. You may have expenses, such as computer equipment or printer ink. You might drive a lot and need to track your mileage. You will probably be able to deduct a decent amount of medical expenses.
“And don’t forget about the home office deduction, which is one of the biggest deductions for the self-employed since it is a portion of your expenses like your rent, mortgage interest, property taxes and utilities based on the percentage of space you use for you home office,” Greene-Lewis says.
Joshua Zimmelman, president of Westwood Tax & Consulting LLC in Rockville Centre, New York, says, “Employees have limits to what expenses they can deduct, but if you’re an independent contractor or freelancer, you can deduct many business expenses. For a Lyft or Uber driver, for example, this might include gas, parking fees, car maintenance and repairs, auto insurance and any other expenses you incur for your car.”
Calculate Your Taxes
If you don’t want to use tax preparation software or hire a tax professional, you can calculate your self-employment taxes by hand. Once you have your numbers, it’s simple division to come up with a dollar amount to send to the IRS.
First, you’ll want to add up all of the income that you earned in 2022, which will be on those 1099-NEC forms and maybe a 1099-K or 1099-MISC form. Then subtract your business expenses.
Typically, 92.35% of your net earnings from self-employment is subject to self-employment tax. To make sure you’re on the right track, you may want to check out the IRS’ instructions on Schedule SE, which will help you figure out the tax due on your net earnings from self-employment.
You’ll then apply the 15.3% tax rate to the amount subject to the self-employment tax.
After that, divide the number by four to arrive at the amount that you should pay the IRS every quarter.
There are a number of self-employment tax calculators online, including one from TaxOutReach.org, which is run by a think tank in the District of Columbia. The job website Fiverr also has a self-employment quarterly tax calculator.
In addition, the IRS provides resources on calculating self-employment tax, including an IRS worksheet to calculate your taxes.
File Your Taxes or Send Them to a Professional
This is a pretty self-explanatory step. Just be sure to give yourself plenty of time if you’re calculating your own taxes. If you have a few days, or even weeks, until the April 18 deadline, and you can spend time preparing your taxes without looking at the clock, you’ll be less likely to make errors.
However, if you wait until the last minute to contact a professional to file your taxes, they will probably end up filing an extension for you. Tax preparers tend to be slammed right before filing day, and they often aren’t able to take on last-minute filers.
Plan for Next Year’s Self-Employment Taxes
Do yourself a favor for next year and start preparing for the taxes you file in 2024. That is, make sure to pay your quarterly self-employment taxes this year.
“Each year, a few new clients come to me with issues from self-employment. The most common is failure to pay estimated taxes,” says Beth Logan, an enrolled agent and owner of Kozlog Tax Advisors in Chelmsford, Massachusetts.
“Self-employed people must pay their federal income tax, their state income tax — if any — and their Social Security and Medicare contributions,” she says. “Self-employed people are both the employer and the employee. Therefore, they pay both halves of the Social Security and Medicare contributions (called self-employed tax or SE tax), which totals 15.3% of profits up to the Social Security income limit.”
That adds up. “When you include SE tax, federal income tax and state income tax, the amount owed can easily be 25% to 40%, even for middle-income Americans,” Logan says.
If you aren’t ready for that, Logan says, it can be pretty shocking to find out what you owe the IRS.
What’s New in Self-Employment Taxes in 2023 That You Should Be Aware Of?
Tax regulations change every year, whether you’re self-employed or working for somebody else. Here are two changes in particular that you may want to be aware of for this year:
Business expense documentation: “One thing to be aware of is that the mileage rate changed during the year, from 58.5 (cents per mile) for the first six months to 62.5 for the second six months,” says Sharon Lassar, a professor and director of the School of Accountancy at the University of Denver’s Daniels College of Business.
This change was made, not surprisingly, due to the higher gas prices last year, according to a press release that the IRS put out.
Form 1099-K: This is more of an issue for next year’s taxes, according to Lassar, but she says you would be wise to think about it now.
“Self-employed individuals who accept payment via Venmo or other third party networks should be sure to use separate accounts for business versus personal transactions,” Lassar says.
She explains that the American Rescue Plan of 2021 changed the reporting threshold for third-party settlement organizations, including payment apps and online third-party settlement organizations.
“The new threshold requires reporting of transactions in excess of $600 per year, changed from the previous threshold of an excess of 200 transactions per year and an excess of $20,000. The law was effective for 2022, but the IRS is delaying its reporting requirements to 2023,” Lassar says.
As Lassar explains it, “TPSOs are required to report payments for goods and services. The law is not intended to track personal transactions such as sharing the cost of a car ride or meal, birthday or holiday gifts, or paying a family member for a household bill. However, it may be difficult for a TPSO to appropriately separate personal from business transactions with 100% accuracy. It is wise, therefore, for individuals to use separate accounts for their business and personal activity.”
The Final Word on How to File Self-Employment Taxes
If you are self-employed and feel overwhelmed and are not ready to prepare your taxes, remember this feeling. And then when you catch a breath, even while you get this year’s tax situation figured out, start working on next year’s taxes now, like saving paperwork and working out the math on your estimated tax payments. Your future self will thank you.
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How to File Taxes When You Are Self-Employed originally appeared on usnews.com
Update 01/25/23: This story was published at an earlier date and has been updated with new information.
