When it comes to tax season, self-employed individuals often envy their employed relatives and friends, wishing they could mechanically input data in a W-2 form and be done with their taxes. Unfortunately, tax season is a bit more complicated for the self-employed folks. Don’t fret because your family and friends envy you not only because of the independence of your profession, but also because you get to claim a host of expenses on your tax return employed people cannot utilize to reduce personal income taxes. Here is our list of top tax tips for the self-employed:
To keep your taxes as simple as possible, stick to the sole ownership or proprietorship form for your business. This will allow you to file your taxes using a relatively easy to complete Schedule C (Form 1040). Self-employed individuals are often advised to incorporate their business or form a limited liability partnership (LLC) to protect themselves from being sued, but this can be achieved without difficulty by signing on for liability insurance (speak to your lawyer). Sole ownership also simplifies your life if you decide to move on and do something else, in which case, there are no dissolution steps to take, unlike a corporation or LLC.
If you have a legitimate hobby, such as sculpting lawn ornaments or breeding cats, which allows you to earn a small yearly income, it may be better not to declare it as self-employment income which is subject to a 15.3% tax on your net income as opposed to zero tax on income from hobbies.
However, if you feel you want to expand your hobby to increase substantially your earnings and make it a full-fledged business by devoting yourself to it fulltime, you will have to declare the revenue as self-employment earnings. In this case, you will be allowed to deduct a host of expenses and even declare a yearly loss. It will help if you can declare a net profit in at least three out of five years so the IRS doesn’t reclassify your activity as a hobby, in which case your deductible expenses will be limited to the income generated from the hobby.
Shoe box accounting is definitely passé and if you still have receipts stuffed in Ziploc bags and shoe boxes, it’s about time you catch up to the 21st century. Your bank and credit card accounts can be directly linked with accounting software. Transactions downloaded periodically from online bank and credit card statements to your accounting software make bookkeeping a breeze.
To simplify your life even more, there are now cloud-based (online) accounting software, such as Quickbooks Online, Wave, Xero, Zoho Books, and many more, which permit you to access your accounting data from anywhere in the world as long as you have internet access. Thus, you can keep your accounting records up-to-date even while you are on a business trip.
Accounting records maintained on computer software will substantially reduce your workload when it will come to file your taxes. These programs generally have reports, such as profit and loss and balance sheet statements for which you can specify dates before generating them. Once the reports are generated, you will have to copy and paste the data required in your personal income tax return.
Stay organized from the first day you decide to become an independent contractor or sole proprietor. Keeping your documents in order, including sales contracts, invoices, delivery records, check stubs and so on, will help you satisfy any document requests made by the Internal Revenue Service (IRS). If an IRS agent is scrutinizing your records and receives timely and organized answers, he or she is more likely to be satisfied regarding the claims you have made on your personal income tax return and is less likely to reject any business expenses.
The IRS has basic tips to help answer questions from self-employed individuals, which you should review to see if there is anything you need to do differently when filing your taxes. The important points of IRS tips are that income from part-time work may have to be included in self-employment revenue, you may be eligible to file your taxes using a simplified Schedule C-EZ if your business costs are below $5,000 and you meet some other criteria, you may have to pay self-employment tax (including Medicare and Social Security taxes) in addition to income tax if your business generated a profit for the year and you may have to make income tax installments throughout the year.
ERNIE BUSTAMANTE