Tax Help for the Self-Employed

Being your own boss means not having to answer to anyone, right? Not exactly. In addition to yourself and your customers, you have tax obligations that require you to answer to the government about your income and expenses. The IRS considers you self-employed if any of the following apply:

Having at least a basic understanding of tax laws and regulations is an essential part of being self-employed. While the focus of this guide will be federal tax requirements and obligations, remember that states — and in some cases, municipalities — also have requirements.

This guide is an overview and cannot address every possible tax situation and self-employment scenario, and it is not a substitute for professional guidance. Think of this guide as a starting point for understanding the nuances of your own particular tax status.

I. Tax Basics for the Self-Employed

Federal income tax returns can either be electronically filed online or filed on paper through the mail. E-filed returns are processed faster, and you receive your tax refund (when applicable) in as few as 10 days, versus up to six weeks for paper returns. A full discussion of the filing procedures can be found in our General Tax Guide.

Self-Employed Tax Statuses

Self-employment income can be categorized into two general types:

  • Income derived from a business you own
  • Income earned as an independent contractor of someone else

In either case, the forms you use to file your tax return depend upon your legal status as a business. Here are definitions for the business statuses pertinent to self-employed filers:

Sole Proprietorship – This status applies to individuals who own and operate an unincorporated business, or, in other words, a business that has not been granted an incorporated corporate status. Typically liability falls directly on the owner – who is often the sole proprietor.

Sole proprietors are required to attach either a Schedule C or a Schedule C-EZ to their 1040 tax return to report self-employment income.

If the business is jointly owned by a married couple , and meets the following requirements , it can be considered a “dual” sole proprietorship for tax purposes:

  • The only participants in the venture are the husband and wife who file a joint return.
  • The business is jointly owned by both spouses and is not an LLC or Partnership
  • Both spouses must materially participate in the business.
  • Both spouses must elect “qualified joint venture status” on form 1040.

In this instance, both spouses must file separate schedules C or C-EZ, with each spouse claiming their portion of income and expenses. This allows each spouse to claim their
share of social security contributions. This should not have any effect on the total refund for
the return.

Schedule C-EZ is a simplified version of the Schedule C and can be used if:

  • Your expenses are less than $5,000
  • You do not have any employees
  • You do not have any inventory
  • You will not be using depreciation or deducting the cost of your home.

Limited Liability Company – An LLC is a business entity formed under state laws that affords certain protections (consult an attorney for a list of those protections in your state). The IRS offers Limited Liability Companies (LLCs) some flexibility in how they are treated for tax purposes.

Single Member LLCs – An LLC with a single member can choose whether or not to be treated as a corporation. Single member LLCs that choose not to be treated as such are required to attach a Schedule C to their federal return. These businesses will often use the owner’s social security number rather than an Employer Identification Number on their return.

S-Corporations – Corporations are business entities that are created following state laws. An LLC that elects to be treated as a corporation must also decide whether or not to use the S election, which allows for income, losses, deductions, and credits to be passed through to shareholders for federal income tax purposes. An LLC that chooses this option is required to use form 1120S when filing their returns. A corporation, including S corps, must file a return regardless of whether it has income or not.

C-Corporations – These are LLCs that are treated as separately taxable entities by the IRS. C-corporations must use a form 1120 to file their federal tax returns and are subject to paying taxes at corporate tax rates, rather than at individual rates. Corporations, in some cases, may be subject to double taxation if corporate income is paid to owners as dividends that are then treated as personal income.

Partnerships – A business with two or more owners (including LLCs) may elect to be treated as a partnership. In a partnership, each person contributes money, property, labor or skills in exchange for a share of the business’s profits and losses.

Like S-corporations, partnership income, losses, deductions, and credits are passed through to the partners and reported on their individual returns. A partnership must file a return unless it had neither gross income nor paid or incurred any amount treated as a deduction or credit for tax purposes. Profits and losses from the business are reported to partners using the Schedule K-1; in addition, the partnership must also file a form 1065 for federal income tax returns.

Self-Employment Taxes

Being self-employed or an independent contractor is more than being your own boss. It means being your own employer — and being an employer comes with tax obligations and filing requirements that go beyond what a wage earner is responsible for. In this section we will run through some of the other taxes and filings that are required.

Social Security and Medicare (FICA) – Unlike wage earners, who have payroll taxes deducted from their gross pay to cover social security and medicare taxes, self-employed individuals who had earnings of more than $400 must complete a Self-Employment Tax form, Schedule SE, and attach it to their personal return. Self-employed individuals and independent contractors are responsible for both the employer and employee shares of social security and medicare. This rule applies to all types of businesses and must be paid even if you are already receiving social security or medicare.

Real Estate Income and LossesSchedule E, Supplemental Income and Loss, is used to report income and losses from real estate. This form is attached to a form 1040 tax return for individuals reporting income or loss from:

  • A real estate rental property
  • Royalties
  • Partnerships
  • S-Corporations
  • Estates
  • Trusts
  • Residual interests in REMICs

The Schedule E instructions include detailed information regarding which expenses are deductible against which types of reportable Schedule E income.

Farm Income – The business of farming is different from other types of self-employment in that it requires a specialized form for tax filing, the Schedule F. This schedule is used to report farm income and expenses and is attached to either the 1040, 1041, 1041NR, 1065 or 1065-B return. The IRS’s Schedule F instructions also include useful information about deductible expenses.

Due Dates

Filing deadlines or due dates for tax returns occur at different times for different types of returns. The final date for filing individual and partnership returns for the 2013 tax year are due by April 15, 2014. The tax filing deadline has not been extended due to the government shutdown, which is causing the IRS to delay the opening of tax filing by two weeks.

Type of Business Required IRS Forms Due Date
Corporation 1120 March 17, 2014
S-Corporation 1120S March 17, 2014
Sole Proprietor 1040, Schedule C (EZ), Schedule SE April 15, 2014
Unincorporated LLC 1040, Schedule C (EZ), Schedule SE April 15, 2014
Real Estate Income 1040, Schedule C (EZ), Schedule SE, Schedule E April 15, 2014
Farm Income 1040, Schedule C (EZ), Schedule SE, Schedule F April 15, 2014
Partnership 1065 April 15, 2014

The forms and schedules listed above only refer to those used as part of your annual federal income tax filing and do not include any state, county or municipal returns required annually or quarterly.

Extensions and Payments – In the event you are unable to complete your tax return by the filing deadline, you are required to file a request for an automatic extension for individuals (form 4868) and a request for corporations (form 7004). Filing an extension does not extend the due date for payments and any taxes due should be paid with the application for extension.

All taxes owed are due in full with your completed return. Payments made after the filing deadline, regardless of whether or not an extension was granted, are subject to interest and penalties. However, it’s possible to request an installment payment agreement. Please refer to our General Tax Guide to learn more about that option.

Installments – In the event you are unable to pay any taxes due at the time of filing, you can complete IRS form 9465, which is an installment payment agreement request for amounts up to $50,000. The following fees apply when setting up an installment agreement:

  • Direct debit agreement – $52
  • Standard agreement or payroll deduction agreement – $105
  • If your income is below a certain level – $43

II. How Employment Taxes Work

In addition to annual income tax returns, self-employed business owners and independent contractors are subject to other taxes and filing requirements. This section deals with those other taxes.

Self-Employment Taxes

When you work for an employer, payroll taxes covering your contribution to Social Security and Medicare are deducted from your wages with a matching amount paid by your employer. As a self-employed person, you are obligated to pay both the employee portion and the employers share; such taxes are generally referred to as self-employment taxes.

For 2013, the Social Security portion of the self-employment tax is 12.4% of your earnings up to $113,700. The maximum you can pay in Social Security for 2013 is $14,098.80.

The Medicare portion of the self-employment tax is 2.9% of your income and does not have an income cap. This means that for every one hundred dollars earned you will owe $2.90. The Schedule SE instructions include a detailed explanation of the tax and filing requirements associated with Medicare.

When you work for someone, payroll taxes for Social Security and Medicare are deducted from your pay and are submitted to the federal government, usually along with a matching employer contribution. Being self-employed does not exonerate you from these taxes; it only changes their name to self-employment taxes and alters the way you pay them.

A wage earner’s (employee’s) contributions to Social Security and Medicare, in the form of payroll taxes, are deducted from their gross income. This means if you earn $100 and your portion of Social Security and Medicare are $10, you will only be responsible for paying income tax on $90 (before any other deductions and credits are applied).

Again, as a self-employed person, you are responsible for not only paying the employee’s share of Social Security and Medicare, but the employer’s share as well. After all, you are your own employer.

Note: The percentages and caps above pertain to 2013 only and are subject to annual change.

Employment Taxes

Self-employed individuals who hire employees (full or part-time) are considered employers, and as such, are subject to reporting, withholding, and paying employee income and payroll taxes in addition to the employer portions of Social Security and Medicare.

Employer Tax Filings – Employers are required to file several tax returns during the course of the year – we discuss those due dates below – in addition to their annual return. These returns must be completed by January 31st. Self-employed business owners who had employees during 2013 are required to file the following returns by January 31st, 2014.

Estimated Taxes

The IRS requires self-employed individuals who anticipate owing more than $1,000 to make an estimated payment of those taxes in advance. This means that if you are self-employed in 2014 and anticipate owing at least $1,000 in taxes for the year, they require estimated payments of those taxes.

Due Dates – Estimated tax payments are generally due by April 15th of the year they are for, so estimated tax payments for 2014 are due by April 15, 2014. The IRS recognizes that paying taxes in advance can be a burden, so they offer the option of breaking the estimated total into four equal parts and making quarterly payments throughout the course of the year using form 1040-ES.

The due dates for estimated payments are:

  • 1st Payment – April 15, 2014
  • 2nd Payment – June 16, 2014
  • 3rd Payment – September 15, 2014
  • 4th Payment – January 15, 2015

III. Keeping Your Business Organized

Without accurate records for your business, you expose yourself to the risk of underpaying taxes and subjecting yourself to burdensome penalties and interest. Accurate records can prevent this, and also offer the following advantages:

  • Monitor the progress, growth and health of your business.
  • Prepare financial statements needed to acquire credit.
  • Keep track of deductible expenses.
  • Prepare your tax returns.
  • Support your return in the event of an audit.

What to Keep – Many self-employed people use one of the many bookkeeping and accounting software packages available, such as QuickBooks, to help organize their businesses and track both income and expenses. The specific records you keep will depend on the nature of your business, but in general, they fall into these categories:

  • Receipts for purchases and expenses
  • Banking records, including statements, deposit slips, and cancelled checks
  • Travel records, including mileage, lodging, and food
  • Entertainment for clients and prospective customers
  • Capital expenses, such as machinery
  • Taxes paid

The IRS recommends that you keep your records until the period of limitations for that return passes, which is generally three years. This ensures that you will always have records on hand to amend past returns or respond to inquiries from the IRS.

If you have any employees, you should retain the following records for at least four years:

  • Your employer identification number
  • Amounts and dates of wages, annuity and pension payments
  • Reported tips
  • Fair market value of in-kind wages paid
  • Names, addresses, social security numbers and occupations of employees
  • Copies of W-2s returned as undeliverable
  • Dates of employment
  • Dates and amounts of tax deposits you make
  • Copies of returns
  • Records of fringe benefits provided

The bottom line when it comes to the IRS is that the burden of proof is yours if the IRS questions anything on your tax return in an audit. Without adequate proof, such as receipts and statements, the IRS can disallow deductions and expenses and add penalties and interest to any additional taxes due.

There are several reputable and reliable business bookkeeping and accounting software packages commercially available. Here are a few to consider:

But before you select a bookkeeping and accounting package, ask your accountant if they will accept records from your software package.

IV. Tax Deductible Expenses

Unlike individual income tax returns, business returns, including Schedule C returns, are full of opportunities to deduct expenses from income earned. You should keep detailed records of everything, including notes regarding your reasoning for any deductible item.

Deductible expenses on a self-employment return lower the amount of taxable income you have, and lower taxable income means a lower tax liability. The scope and number of potential business deductions is far greater than can be discussed in this guide, but they must meet the test of being ordinary and necessary.

Ordinary and Necessary – The IRS uses the ordinary and necessary standard to determine if an expense is deductible. For an expense to be considered necessary, it must be considered helpful and appropriate to your trade or business. An ordinary expense is one that is common and accepted in your trade or business. For example, a furniture maker needs certain tools to carve and shape wood into furniture, so those tools would be an ordinary expense.

Not all expenses are deductible in the year you incur them. In fact, some expense may not be deductible at all. Let’s say you are operating your business using cash basis accounting and make a purchase in November, but do not pay for it until January – those expense won’t be deductible for the tax return November falls under. Certain types of expenses, such as capital expenses (used to start the business), are not deductible, which is why you must show the difference between a usual business expense and other expenses, such as the cost of goods sold, which have their own separate rules for deductibility.

IRS publication 535 explains in greater detail the rules for certain types of expenses, such as:

  • Cost of goods sold
  • Capital expenses
  • Capital vs deductible expenses
  • Personal vs business expenses

Travel, Entertainment, Gift and Car Deductions – These expenses are covered by IRS publication 463. There are separate rules for travel within the United States and international travel, for example. The IRS rules say that “if any part of your business trip is outside of the United States, some of your deductions for the cost of getting to and from your destination may be limited.” More information about international travel and expenses can be found here.

The rules for entertainment include the direct relationship test, which says that for an entertainment expense to be deductible, it must be directly related to your business. There are three requirements that must be met for entertainment to be considered a deductible expense.

  • The main purpose of the combined business and entertainment was the active conduct of business.
  • You engaged in business with the person during the entertainment period.
  • You had more than a general expectation of getting income or some other specific benefit at some future time.

Casualty and Theft Losses – The IRS considers casualty losses to be damage destruction or loss of property from an identifiable event that is sudden, unexpected or unusual. Such losses are defined as:

  • Sudden – An event that occurs swiftly and is not gradual or progressive.
  • Unexpected – This is an event that is ordinarily unanticipated or unintended.
  • Unusual – Something that is not a day-to-day occurrence and is not typical.

Examples of casualties are:

  • Fires
  • Earthquakes
  • Car accidents
  • Floods
  • Cave-ins
  • Shipwrecks
  • Storms

Theft does not include property that is mislaid or lost. For example the accidental disappearance of property or money is not a theft. A theft is defined as the taking and removing of money or property with the intent to deprive the owner of it. The taking must be illegal under the law of the state where it occurred. Examples of theft are:

  • Blackmail
  • Burglary
  • Embezzlement
  • Extortion
  • Larceny
  • Robbery

Home Business Expenses

Many self-employed individuals work from home and the IRS allows for the business owners to deduct a portion of the home expenses as a business expense provided they meet certain tests:

  • A portion of your home must be used “exclusively and regularly” as your principal for your place of business.
  • It must be a place where you exclusively and regularly meet or deal with patients, clients or customers in your normal course of business.
  • If it is a separate structure it must be used for your business.

There are two exceptions to the exclusivity rule:

  • You use part of your home for the storage of inventory or product samples.
  • You use part of your home as a daycare facility.

An example of a non-exclusive use would be a room used during the day for conducting business and used in the evening or weekends for leisure. Even though you are working in the space fulltime during business hours, it retains other uses and is therefore not deductible as a home business expense.

Beginning with the 2013 tax year the IRS is instituting a trial program, offering business owners who claim a deduction for office in the home a simplified method for calculating the deduction.

Other helpful publications for determining business deductions and expenses are publication 547, which covers casualty and theft losses. IRS publication 587 offers a great deal of guidance regarding the business use of your home and related deductible expenses and limitations.

The IRS publication 536 presents information regarding deductions rules for net operating losses, including carryforwards and carrybacks. Finally, publication 529 includes information regarding miscellaneous deductions. As always, it is important to carefully review all relevant IRS publications before filing your return.

Self-Employment Retirement Plans and Your Taxes

Self-employment places the responsibility for retirement planning exclusively with the individual business owner. Retirement planning options should be afforded serious consideration as far in advance of retirement as possible.

Self-employed individuals have a multitude of retirement planning options available because they are both the employer and the employee, and as such, can tailor a plan that precisely matches their needs. Proper retirement planning requires you to research the risks and benefits of different options; a task that is beyond the scope of this guide. Nonetheless, we’ve identified some of the basic retirement plans available to you and their tax requirements in order to get you started.

Simple IRA Plan – This plan permits you to put all net earnings from self-employment into it. It comes with either a 2% fixed contribution or a 3% matching contribution. To establish the plan, fill out form 5305-SIMPLE, form 5304-SIMPLE, or a “prototype SIMPLE IRA plan” form. Following the successful completion of the form, you can then open a SIMPLE IRA with a bank or another comparable financial institution.

Simplified Employee Pension – A SEP plan provides business owners with a simplified means to contribute to their employees’ retirement as well as their own. Contributions can be made to an IRA (individual retirement account) for each of the plans’ participants. Publications 560 and 590 provide detailed information on both SEP and SEP-IRA plans respectively.

One-Participant 401(k) Plan– This is a brand of 401(k) specifically tailored to the self-employed person who serves as the “employer and employee.” There are a number of details that make this plan unique in comparison to other 401(k)s; consult the IRS’s guide to one-participant plans to fully understand the plan’s requirements and options.

Discussion of additional options available to the self-employed can be found here.

V. Additional Resources

Preparing and filing your own income taxes when you are self-employed takes time, and you
should begin the process of research and gathering documents as soon as possible to ensure you have enough time to properly prepare your return. The benefits of preparing your own taxes include great saving in the cost of preparation. However, it is important to remember that having self-employment income can make the process more complicated. As your business grows, you should consider reaching out for professional tax assistance.

Regardless of whether you prepare your own returns or employ a professional accountant to assist you, the person who is ultimately responsible for the accuracy of your return is you. In addition to the IRS, there are numerous resources available for individuals and self-employed people.

Free Tax Preparation Assistance

  • The IRS VITA program offers the assistance of IRS-Certified volunteers to help individuals who earned less than $51,000. You can use the VITA Locator Tool to find volunteers in your area.
  • The IRS operates Taxpayer Assistance Centers that can be visited in person or contacted by phone and are available to answer questions and provide guidance.
  • Military One Source provides assistance to servicemembers including ROTC and Academy students.
  • The IRS Taxpayer Advocate Service is available if you feel you have been treated unfairly by the IRS.
  • The Small Business Administration offers a range of services online and in person.
  • SCORE provides volunteer mentors composed of retired business people and executives.