Self-employment seems like the perfect set-up. What could be better than reaching your dreams your way? However, there is one downfall. Wage earners who work for employers have their taxes withheld from their wages and deposited with the IRS. Meanwhile, the self-employed have to calculate and pay their taxes themselves. Self-employment tax rules are different from those for businesses, individual taxpayers and those working for employers. Generally, the IRS requires self-employed individuals to file a tax return if they earn $600 or more from self-employment.
Many times, you can underreport income and incur a tax debt due to not understanding IRS requirements or a lack of information. If you are self-employed, consider the tax rules below when calculating and paying your taxes.
Self-employed individuals must pay the self-employment tax in addition to federal income tax. Self-employment tax includes the individual’s Social Security and Medicare taxes. You also must pay an additional Medicare Tax of 0.9 percent. This additional Medicare Tax applies to wages, compensation, and self-employment income that is above a certain threshold.
Self-employed individuals may also be required to pay Estimated Quarterly Taxes. Estimated taxes include self-employment income and any other tax an individual must pay. As the name implies, these taxes are paid at specific intervals throughout the year. Generally, if you expect to owe more than $1,000 in taxes by the end of the year, you should be filing estimated taxes.
Many times, self-employed individuals do not pay estimated taxes quarterly and wait for the traditional filing deadline. This leads to tax debt, as correctly paying estimated taxes every quarter is necessary to remain compliant with the tax laws. The IRS even charges a penalty for underpayment of estimated tax.
Tax Credit and Deductions
There are many deductions that you can claim. You can deduct certain qualifying business expenses from income to reduce taxes. Many self-employed individuals who work from home use the Home Office Deduction.
Self-employed individuals can claim the Earned Income Tax Credit if they file Form 1040 Schedule C. This tax credit reduces the tax liability of those employed by an employer or work independently.
Want to avoid mistakes in calculating taxes and running the risk of a debt? Either seek the help of a tax professional or keep yourself up-to-date about the tax laws that impact you.