Self-employed individuals have unique tax needs. In addition to being potentially eligible for additional deductions and credits, they are required to submit estimated income tax payments on a quarterly basis.
Deductions for Self-Employed Individuals
Self-employed individuals are eligible for several types of tax deductions and credits that traditionally employed individuals are not. These include deductions for business expenses, including office supplies and the cost of operating a home office, medical expenses and education costs. Tax Topic 500 contains lists of the deductions available to self-employed persons. The most notable of these deductions include:
- Business Expenses: This category of deductions includes office supplies, Internet or phone connection costs and even the percentage of the individual's home used as a home office. It also includes business lunches, mileage driven for business purposes and entrance and other fees charged for networking events.
- Continuing Education Costs: Expenses associated with continuing education, regardless of whether they are required to maintain licensure or certification, are deductible. Purchases of newspaper or other publication subscriptions related to the individual's field of work are similarly deductible.
- Medical Premium Payments and Bills: Because self-employed individuals do not have the ability to join an employer-sponsored health insurance plan, they are able to deduct the cost of their monthly health insurance premium payments. Other medical expenses, such as copayments, prescription bills and medical equipment can also also deductible under certain circumstances.
- Depreciation: Self-employed persons can deduct the depreciation of any equipment they purchase for business purposes. The deduction must be claimed over the period of the item's use.
Self-Employment Tax Strategy
The basic strategy for all self-employed individuals is to keep records of all income and expenses, as well as any paperwork substantiating those numbers. June Walker, an accountant specializing in providing advice to self-employed persons, advises using a database to track received income. This database does not need to be extremely complex or even part of an overall accounting system, a simple spreadsheet suffices.
Walker also advises that any documents related to income and expenses be kept for a minimum of six to seven years from the date the document last affected the individual's income or tax return. Potentially, therefore, receipts could be kept for ten or more years. Receipts include not only records of expenses, but also any documentation related to any claimed deductions or credits.
Income tax returns, Walker states, should be retained indefinitely. Other documents, such as pension forms, employment agreements, loan or lease documents and business insurance policies should also be kept indefinitely.
Like any other working individual in the U.S., self-employed individuals must pay taxes on their income. This tax, called the "Self-Employment (SE) Tax" is the equivalent of paying social security and Medicare taxes. SE taxes are due from any individual earning more than $400.00. The specific amounts owed are based on the individual's net earnings, meaning the amount they earned after subtracting expenses. As of 2011, the tax rate is 13.3 percent, a two percent decrease from previous years. Self-employed individuals must submit payment at least quarterly; failing to pay anticipated taxes subjects the individual to penalties.
Geoff Goudy, CPA, LLC, advises self-employed individuals to set aside money each month to pay for SE taxes. Goudy recommends that individuals earning more than $250,000 set aside 25 percent of their total earnings over the course of a year to pay for taxes. This means that each quarter the individual would save 6.25 percent of their net earnings for tax purposes. For individuals earning less, Goudy recommends saving anywhere from 10 to 20 percent of earnings. These amounts, he states, will be enough to pay estimated taxes.
The Self-Employment Tax Initiative
The Corporation for Economic Development offers small business owners and self-employed individuals assistance preparing and filing their personal and corporate tax returns. This service, called the "Self-Employment Tax Initiative" (SETI), is available throughout the U.S. Generally it assists with filing a self-employed individual's first return.
Answering Your Tax Questions
If you are self-employed, consult the IRS website or a professional accountant for answers to any specific tax questions you may have. The IRS operates a Small Business and Self-Employed Tax Center to assist self-employed individuals, sole proprietors, small business owners and independent contractors with general tax questions. This Center, which is provided through the agency's website, provides tax forms, information on how to apply for an employee identification number, employment tax information and basic guidance about the new health care laws. It also contains links to state tax website and other small business resources.