Self-employment is the opportunity to be your own boss, to come and go as you please, and oh yes, to establish a lifelong bond with your accountant. If you’re self-employed, you’ll need to pay your own FICA taxes and take charge of your own retirement plan, among other things. Here are some planning tips.
UNDERSTAND SELF-EMPLOYMENT TAX
As a starting point, make sure that you understand (and comply with) your federal tax responsibilities. The federal government uses self-employment tax to fund Social Security and Medicare benefits. If you file a Schedule C as a sole proprietor, independent contractor, or statutory employee, the net profit is self-employment income and must be included on Schedule SE to calculate self-employment tax.
MAKE YOUR ESTIMATED TAX PAYMENTS ON TIME TO AVOID PENALTIES
Employees generally have income tax, Social Security tax, and Medicare tax withheld from their paychecks. But if you’re self-employed, it’s likely that federal and state taxes are not being withheld from your income. As a result, you’ll need to make quarterly estimated tax payments on your own to cover your federal income tax and self-employment tax liability. Keep in mind that you may have to make state estimated tax payments, as well.
ESTABLISH AN EMPLOYER-SPONSORED RETIREMENT PLAN
Because you’re self-employed, you’ll need to take care of your own retirement needs. You can do this by establishing an employer-sponsored retirement plan, which can provide you with a number of tax and nontax benefits. Contributed funds, and any earnings, aren’t subject to federal income tax until withdrawn. You can also choose to establish a 401(k) plan that allows Roth contributions. You may want to start by considering the following types of retirement plans:
- Keogh plan
- Simplified employee pension (SEP)
- SIMPLE IRA
- SIMPLE 401(k)
- Individual (or “solo”) 401(k)
The type of retirement plan that your business should establish depends on your specific circumstances. Explore all of your options and consider the complexity of each plan. And bear in mind that if your business has employees, you may have to provide coverage for them as well.
Starting a new business can be a challenging situation, but with the right planning, your venture can become your best investment.
DEDUCT HEALTH-CARE RELATED EXPENSES
If you qualify, you may be able to benefit from the self-employed health insurance deduction, which would enable you to deduct the cost of health insurance that you provide for yourself, your spouse, and your dependents. This deduction is taken on the front of your federal Form 1040 when computing your adjusted gross income, so it’s available whether you itemize or not.
TAKE FULL ADVANTAGE OF ALL BUSINESS DEDUCTIONS TO LOWER TAXABLE INCOME
Because deductions lower your taxable income, you should make sure that your business is taking advantage of any business deductions to which it is entitled. To be deductible, business expenses must be both ordinary (common and accepted in your trade or business) and necessary (appropriate and helpful for your trade or business). If your expenses are incurred partly for business purposes and partly for personal purposes, you can deduct only the business-related portion.
If you’re concerned about lowering your taxable income this year, consider the following possibilities:
- Deduct the business expenses associated with your motor vehicle
- Buy supplies for your business late this year that you would normally order early next year
- Purchase depreciable business equipment, furnishings, and vehicles this year
- Write off any bad business debts
Self-employed taxpayers who use the cash method of accounting have the most flexibility to maneuver at year-end.
Starting a new business can be a challenging situation, but with the right planning, your venture can become your best investment.
Rachel Duncan | Tax Advisor | rduncan@bwfa.com