If you’re self-employed, you know what it’s like to live the dream: choosing your own hours, picking your own projects, and working from anywhere are perks most employees can only dream of. But with all that flexibility, you still can’t outrun life’s two great certainties: death and (filing your own) taxes. If you’re new to the gig economy, you may be surprised to learn that in addition to filing an annual income tax return, you must also pay quarterly estimated income taxes. Unlike regular employees, self-employed individuals also have to pay the full amount of their FICA Social Security and Medicare taxes (self-employment tax). It may be tempting to pretend self-employment taxes don’t exist, but not paying the correct amount of taxes on time can lead to the IRS fining you with penalties, late fees, and interest. Luckily, we’re here to help with these step-by-step instructions for how to file your own self-employment taxes.
How to File Taxes If You’re Self-Employed
Because of governmental reactions to COVID-19, there's expected to be a lot of changes to self-employment taxes. Proposed legislation could bring tax breaks. Additionally, the IRS is expected to announce a new deadline for 2019 tax filing in addition to penalty-free tax deferment. We’ll keep you posted.
How to file self-employment taxes step by step
Step 1: Determine if you owe self-employment taxes
First off, how do you know if you’re self-employed? If you are an independent contractor, sole proprietor, or freelancer who works for other businesses or individuals, the IRS sees you as a self-employed business. That means you must pay self-employment taxes if your net earnings are more than $400 (after subtracting expenses) in a tax year.
So how are taxes different for self-employed folks? For one things, you’ll work with some additional tax forms. Instead of a W-2, you may receive 1099-MISC forms reporting your gross income at the end of the year. This means that the businesses who paid you for your services did not consider you an employee.
So if you’re not your client’s employee, how does that change your tax rates? Because you weren’t a traditional employee, the businesses paying you did not withhold federal income tax, Social Security tax, or Medicare tax for you. As a result, you’re the one responsible for withholding and paying all of your own self-employment taxes based on your net income. And that means a higher tax rate.
Let’s break it down even further: If you’re self-employed, you file an annual tax return and pay quarterly taxes. Each quarter, you need to pay an estimated income tax and self-employment tax based on your net income. Heads up: the self-employment tax includes the portion of your Social Security and Medicare taxes that your client didn’t have to pay (because, remember, you’re not their actual employee). That’s why self-employed workers are taxed at a higher rate than employees at a typical job: you’re paying both the employee and the employer’s share of Social Security and Medicare.
Even if you only work part-time, are paid in cash, or do not receive a 1099-MISC form (businesses are only required to send you a 1099-MISC if they pay you more than $600 in a year), you must still pay self-employment taxes if you meet these qualifications.
Step 2: Calculate your quarterly estimated tax liability
Many people don’t realize that the IRS actually requires you to pay taxes quarterly. If you don’t, you’ll have to pay interest. Employers meet this requirement by withholding taxes from employees’ paychecks all year long. But when you’re self-employed, you must make estimated tax payments every quarter if you expect to owe $1,000 or more on your annual tax return.
To calculate your quarterly taxes,, first estimate how much income tax you will owe at the end of the year. You can base this on your last year’s income if you have been self-employed for longer than a year and have the prior year’s federal tax return on hand. All you have to do is divide the amount of taxes you paid last year by four and then pay that amount quarterly. You may need to increase or decrease the amount if you think you will earn a different amount this year.
If you’ve never paid taxes as a self-employed individual and can’t base your estimated income taxes on last year’s tax return, then use the estimated tax worksheet on 1040-ES, Estimated Tax for Individuals to determine your how much to pay quarterly based on your expected gross income, expenses, exemptions, credits, and tax deductions for the year.
One of the perks of self-employment is that as an owner of a small business, you are eligible for certain business-related tax deductions that can decrease your taxable income. Self-employed people may be able to consider the following business expenses as tax-deductible if they were used for business purposes:
- Cost of maintaining a home office
- Business start-up costs
- Business-related supplies, such as a computer, printer, and paper
- Use of their vehicle, travel expenses, and gas
- Internet and phone bills
- Self-employed health insurance premiums for themselves and their family members
- The employer-equivalent portion (7.65%) of their self-employment tax
- Self-employment retirement contributions
Be sure to follow the IRS’s guidelines for what qualifies as a business expense, and keep all receipts related to your deductions as proof in case you are audited.
Once you’ve calculated your tax deductions and your estimated self-employment net earnings for the year, add those numbers together. Then divide the total by four and use that amount to make your quarterly estimated payments. If you realize after a quarter that your estimated income was too high or too low, simply redo Form 1040-ES to lower or raise the amount of taxes you pay the following quarters. Just be careful, because if you underestimate and don’t pay enough, you may have to pay a penalty.
Step 3: Determine your SE (self-employment) tax payments
Your quarterly estimated taxes are made up of income taxes, which you calculated in Step 2 above, and self-employment (SE) taxes, which are comprised of Social Security and Medicare taxes. The self-employment (SE) tax rate is 15.3% (12.4% goes towards Social Security, and 2.9% goes to Medicare). If you were a traditional employee, this tax would be split between you and your employer. But as a self-employed individual, you are responsible to pay the full amount of these taxes yourself each quarter. You can use the Schedule SE (Form 1040), Self-Employment Tax worksheet to determine the amount of SE taxes to pay every quarter based on your projected net earnings from self-employment. You will find Schedule SE instructions on the Schedule SE form. Hold onto your SE Form after you complete it because you will need it when it’s time to file your annual tax return.
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Step 4: Pay your quarterly estimated and SE taxes on time
Now that you have calculated your estimated income and SE (self-employment) taxes for the year using steps 2 & 3, it is time to make quarterly tax payments on these two amounts. Estimated taxes are generally due four times a year on April 15, June 15, September 15 and January 15, give or take a day or two.
Most self-employed people use the 1040-ES, Estimated Tax for Individuals form to make their quarterly estimated payments. You can make quarterly estimated payments to the IRS online, by phone, or by mail using the vouchers found on Form 1040-ES. Remember to pay quarterly state and local taxes at the same time as quarterly federal taxes.
If you did not realize you needed to make quarterly estimated payments and have missed a due date, pay what you can immediately to avoid even greater charges because the penalty is based on how many days the payment is late. Even partial payments are better than no payments, because then you will only be charged penalties on the amount that is missing.
Step 5: File your annual self-employment tax return
At the end of the year, self-employed individuals who have made a net income of over $400 must file their annual tax return using Form 1040, U.S. Individual Income Tax Return. Use the 1099-MISC forms you received from your clients to help you fill out the 1040 form. Remember that even if you did not receive 1099 forms, you are still responsible for keeping track of all the payments you received throughout the year and paying taxes on them.
In addition to the 1040 form, self-employed people must fill out and attach a Schedule C (or Schedule C-EZ depending on your expenses) to claim their deductibles and report how much income they made or lost that year. Along with the Form 1040 and Schedule C or Schedule C-EZ, self-employed individuals must attach the Schedule SE form they used to determine their self-employment taxes in Step 3.
Tips for making it easier to pay self-employment taxes:
- Create a business plan, and keep detailed records of payments received, business expenses, and monthly profit and loss statements. Keep track of 1099-MISC forms you receive from clients. These records will help you file taxes and pass an audit.
- Keep your self-employment bank account and personal bank account separate. Create a separate account for your self-employment business so that all your self-employment income and expenses are automatically recorded in one place.
- Set aside money every month so that paying the quarterly estimate taxes won’t be as painful. If you set aside 30% of your income, you should be prepared. You may need to save more if you have additional state or local taxes.
- If possible, it’s best to pay more of your estimated taxes at the beginning of the year because many independent contractors and freelancers experience a decrease in business toward the end of the year.
- Use one of our recommended tax software to make the whole self-employment tax filing process much easier and less stressful.
Filing small-business taxes—especially when you’re self-employed—is no easy feat. So pat yourself on the back when you’ve finished! If the whole process seems too daunting to complete on your own, check out our list of the best tax software to use if you are an independent contractor, freelancer, sole proprietor, or small business.
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- FreshBooks, “Second Annual Self-Employment Report”