Tax Tips for the Self-Employed
Updated: Dec 4, 2020
Whether you freelance or own a small business, being self-employed comes with a host of challenges and responsibilities, including unique tax requirements. If you are considered self-employed for tax purposes, it is up to you to accurately track and report your income and make any required tax payments. Maintaining a clear understanding of your tax responsibilities will give you peace of mind during tax season and throughout the rest of the year.
Self-employed individuals fall into three different categories:
Any member of a partnership
A sole proprietor is the owner of an unincorporated business (in other words, a business that has not been restructured into a separate legal entity such as an S-Corporation). Sole proprietorships are considered pass-through entities. Pass-through entities are not subject to federal income tax; instead, a business’s owners are taxed individually on their income from the business.
An independent contractor performs work or provides services for another entity as a non-employee. Freelancers are considered independent contractors. Because payroll taxes are not deducted from independent contractors’ earnings, their income is subject to self-employment taxes as well as income taxes. Independent contractors are generally considered sole proprietors by the IRS for tax purposes.
Sole proprietors and independent contractors are required to pay self-employment taxes.
A partnership is the simplest type of structure for a business owned by two or more people. The two most common types of partnerships are Limited Partnerships (LPs) and Limited Liability Partnerships (LLPs). Like sole proprietorships, partnerships are considered pass-through entities.
Note that for tax purposes, a single-member LLC or LLP is considered a disregarded entity. This means that although a business is considered a separate legal entity, it is taxed through the business owner’s personal tax return, much like a sole proprietorship.
Members of limited partnerships are only required to pay self-employment taxes if the partnership is engaged in business activities other than rental real estate.
Know Your Employment Classification
Are you considered an independent contractor or an employee? Tax obligations are largely determined by your employment classification. Because independent contractors and employees often engage in similar work, it can be tricky to figure out which category you fall into.
To determine whether you are an employee or an independent contractor, ask yourself two questions:
1. Did I have to fill out a W-4 or a W-9?
If you were required to file a W-4 when you started your job, then you are considered an employee. The W-4 form tells your employer how much of each paycheck to withhold for taxes.
If you were required to fill out a W-9 upon being hired, then you are classified as an independent contractor. The company that hired you uses the information from your W-9 to accurately report the payments they make to you throughout each tax year.
2. Do I receive a W-2 or a 1099-MISC at the end of the year?
Companies use Form W-2 to report all payments made to an employee during the year. If a company pays an independent contractor $600 or more in a calendar year, they must prepare a 1099-MISC. Accordingly, if you receive a W-2 from your employer at the end of the tax year, you are considered an employee; if you receive a 1099-MISC, then you are considered an independent contractor.
Important Tax Forms for the Self-Employed
Come tax season, a few forms are particularly important for self-employed taxpayers:
Form 1099-MISC: Miscellaneous Income
If you are an independent contractor, you will receive a 1099-MISC at the end of the year from any entity that paid you $600 or more for your services during the year. This form provides the income information you'll need to complete your tax return.
Schedule C: Profit or Loss from Business (Sole Proprietorship)
You will need to fill out a schedule C to determine your net earnings from self-employment. This includes income from business activities that you engaged in as a sole proprietor or independent contractor. For tax purposes, a "business activity" is any activity that you regularly engaged in during the tax year with the primary purpose of earning income or profit.
Working a side hustle? You may be required to pay self-employment taxes even if it isn't your full-time gig. If you earn income from a side business in addition to your regular employment, you are still considered self-employed for tax purposes.
Schedule SE: Self-Employment Tax
Schedule SE is used to determine how much tax you owe on your net earnings from self-employment. The information provided on your Schedule SE is also used by the Social Security Administration to determine your Social Security benefits.
You must file a Schedule SE if you meet either of the following criteria for the tax year:
Your net earnings from self-employment (excluding some church employee income) were $400 or more.
You received church income of $108.28 or more.
Schedule 1040-ES: Estimated Tax for Individuals
Taxes must be paid on earned or received taxable income throughout the year. Taxpayers meet this requirement via paycheck withholding or by making estimated payments.
Anyone who expects to owe at least $1,000 in taxes on their next return is required to make estimated payments.
Individuals who receive wages or a salary from an employer pay taxes through withholding. Through withholding, a specified portion of an employee's earnings is withheld from each paycheck. Employees can adjust this withholding amount as their income changes to avoid the need to make estimated payments during the year.
Because earnings from self-employment are not subject to withholding, self-employed individuals are usually required to make estimated payments. If you earn income as a sole proprietor or independent contractor, use Form 1040-ES to calculate your estimated tax amount.
Note that other forms of income that isn't subject to withholding (such as interest earnings, alimony, or rental income) is also taken into account for estimated tax purposes.
Estimated Payment Due Dates
For tax year 2020, taxpayers can choose to pay their full estimated tax amount by April 15th, 2020, or in four equal installments, due by the following dates:
1st Quarter Payment: April 15th, 2020
2nd Quarter Payment: June 15th, 2020
3rd Quarter Payment: September 15th, 2020
4th Quarter Payment: January 15th, 2021
Estimated payments can be made in the following ways:
By phone via EFTPS (Electronic Federal Tax Payment System)
Via the IRS2Go mobile app
Electronic Funds Withdrawal (EFW) for e-filers
By mail (check or money order with payment voucher)
If you choose to mail your estimated payment, the postmark date is considered the date of payment.
We hope you’ve found this post helpful! For additional tax guidance from our experienced accountants and consultants, give Seymour & Perry, LLC a call at 706-549-8197.