Labor Day is a day off for many workers. But entrepreneurs probably put in regular shifts this first Monday in September.
When your small business depends primarily on you, you tend to work even on holidays.
Since you're busy being the boss, I won't take up too much of your time. But whether you're a new business owner or have been the boss for years, it's always good to stay on top of your tax responsibilities.
Here are some tax basics for all of us self-employed individuals.
Self-employment definition: For anyone starting a small business, especially those who are self-employed, you generally meet the Internal Revenue Service's definition of self-employment if you —
- Carry on a trade or business as a sole proprietor or independent contractor, or are otherwise in business as an individual, including a part-time business, or
- Own an unincorporated business.
Independent contractors are generally people such as doctors, daycare providers, mechanics, and contractors who are in an independent trade, business or profession in which they offer their services to the public. That's me, a freelance writer and blogger.
But since taxes are involved, whether you're an independent contractor or employee depends on the facts in each case.
The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
Getting a special tax reporting number: When we file our individual taxes, we use our Social Security number on the returns.
But when you're operating a business, you might need to obtain an Employer Identification Number (EIN) from the IRS.
The fastest and easiest way to get an EIN is online at IRS.gov. Type EIN in the search box. The IRS issues the EIN immediately after validating your information.
Situations where you need an EIN include when you —
- Pay wages to employees,
- Operate a business as a corporation or partnership, or
- Are required to file any tax returns for employment, excise, fiduciary, or alcohol, tobacco and firearms.
If you don't need an EIN, you Social Security number will suffice.
Paying self-employment tax: Now about those returns that have either your EIN or Social Security number. As a self-employed individual, you generally must file an annual federal income tax on your earnings, just like when you got a salary.
When you run your business as a sole proprietor, you'll report those earnings (or losses) on Schedule C.
You also must pay self-employment income tax if your net earnings from the enterprise are $400 or more. If you don't make at least that much in a year, you might want to re-examine your business plan.
The $400 threshold technically triggers self-employment taxes. This is the money that employees see taken out of they paychecks as Federal Insurance Contributions Act taxes.
When you work for someone else, you and your employer each pay a 6.2 percent Social Security tax on up to $160,200 of your earnings. That earnings amount is for the 2023 tax year. It's adjusted annually.
You and your boss also each must pay a 1.45 percent Medicare tax on all earnings.
However, when you're self-employed, you pay the combined employee and employer amount. This amount is a 12.4 percent Social Security tax on up to $160,200 of your net earnings and a 2.9 percent Medicare tax on your entire net earnings.
And if your business is very successful and your earned income is more than $200,000 ($250,000 for married couples filing jointly), you must pay 0.9 percent more in Medicare taxes.
These self-employment taxes are reported on Schedule SE.
You do, however, get to recoup half of your Social Security tax on IRS Form 1040, Schedule 1 as an income adjustment, popularly known as one of the two dozen above-the-line deductions.
As for the income tax on your self-employment earnings, as noted at the top of this section when your income is as a sole proprietor, you'll report what you make, or your losses, on Schedule C.
Claiming business expenses: Schedule C is also where you'll deduct the costs of operating your business.
These are expenses that you can deduct in the current year, and as the form excerpt below shows, it lists the most common ones. You also can find out about deductible business expenses in Schedule C's instructions.
As will all tax deductions, don't get creative. In fact, IRS examiners pay particular attention to small business deductions.
Remember that for a business expense to be deductible, it must be both ordinary and necessary. An ordinary expense is one that is common and accepted in a taxpayer’s field of business. A necessary expense is one that is helpful and appropriate for a business.
Home office claims: If you use part of your home for your business, you may be able to claim a deduction for your home work space.
The home office deduction is available for homeowners and renters, and applies to all types of homes.
But you also must meet the IRS requirements. I highlight them in my most recent home office deduction post, but I want to reiterate a couple of key ones here.
First, you can claim a home office as a deduction only if it's a job you own and operate, either as your main business or as a side job to supplement your earnings as an employee.
Second, your home office must be used exclusively for conducting business on a regular basis. And the home office space must be for your principal place of business.
In addition to my aforementioned home office post, you can find more about this tax break in IRS Publication 587, Business Use of Your Home (Including Use by Daycare Providers). You'll also want to check out the possibility of using the simplified home office deduction.
Paying estimated taxes: The U.S. tax system is pay as you earn. That's taken care of for most taxpayers through paycheck withholding. But when you run your own business, you must make sure the associated income tax is paid in a timely manner.
For self-employed people, that's generally done by making estimated tax payments. Quarterly estimated tax payments are due the 15th of each April, June, September, and January.
If you don't make quarterly payments, or don't pay the correct amount each period, you could face underpayment penalties at filing time.
Most estimated tax payments are made electronically. If, however, you're old-school, you'll pay your four estimated tax amounts using a Form 1040-ES voucher that you send along with your payment.
You can read more on estimated taxes in my posts —
- A quick estimated tax Q&A
- Ways to pay estimated taxes
- Estimated taxes: Why, when, and how to pay them
Record keeping is key: Maintaining complete records is critical in all tax situations, but even more so for business owners.
You need to keep track of receipts, sales slips, invoices, bank deposit slips, canceled checks, and other documents related to your business' operation. These documents, either electronic or paper files, can substantiate your income, as well as any deductions and credits you can claim.
That's why you also need to keep your business records clearly separate from your personal tax and financial records.
If the IRS questions your business filing and you don't have the records to prove what you entered on your return, you could lose valuable write-offs and owe more tax.
In addition to the links in this post, you also might find these business tax items of interest:
- A Labor Day salute to new entrepreneurs
- Tax implications of business entity choices
- 5 tax considerations for young workers and their parents
You also can find more business tax posts in the ol' blog's, what else, business category.
🌟 Search Amazon Business and Money Books 🌟
The text link above and image links below are affiliate ads. If you click through and then buy a product, I receive a commission.