A Tax Guide for Solopreneurs

tax guide for solopreneurs

Solopreneurs are individuals that work for themselves.

According to U.S. Census data, the number of self-employed people is growing at an all-time high rate. Millions of Americans are leaving their jobs to work for themselves. There are many benefits that come from being your own boss. Yet, that does give you ultimate freedom at tax time.

As a solopreneur, you are responsible for paying state, federal, and self-employment taxes.

To run your own business, you need to understand exactly how to prepare for tax time. The goal of this article is to provide you with the tools you need to cruise past Tax Day.

Business Classifications for Solopreneurs

There are a variety of one-person businesses recognized by the Internal Revenue Service (IRS).

Independent Contractors

Independent contractors are tradespeople who offer their services to the general public. According to the IRS, independent contractors can be doctors, writers, accountants, and much more. When someone hires an independent contractor, they can only influence the end outcome of the service they have requested. In other words, they cannot tell the contractor how or what is done to achieve the end outcome.

Sole Proprietor

Sole proprietors own unincorporated businesses on their own. Sole proprietorships are not legal entities. As such, they are taxed in the same way as independent contractors. According to the IRS, sole proprietors are not taxed in the same way as LLC owners.

Partnership

A partnership is a business that is a cooperative relationship between two or more people. Partners are responsible for contributing to a partnership’s spending, property, labor, and/or skills. As such, each partner shares in a percentage of the company’s profits and losses. Partnerships must file an annual information return together. Yet, each individual partner is also responsible for paying solo business taxes on their share of the profits and losses.

A Tax Guide for Solopreneurs

Don’t allow your personal finances to override the benefits of being your own boss. If you can wear the many hats required of a solo business owner, then paying solopreneur taxes should be a walk in the park. Getting things right starts with a keen understanding of your obligations as a taxpaying citizen. In the section below, you’ll find a more palatable version of the IRS’s guide to solo business taxes.

Maintain Detailed and Accurate Records

Successful small business tax filings start long before tax season. Whether you are a freelance writer or an internet salesperson, you need to keep accurate, up-to-date financial records. These must include detail-oriented profit and loss statements as well as accurate expense ledgers.

For many first-time solopreneurs, balancing day-to-business and keeping track of finances can be a challenging juggling act. Businesses with little to no operating expenses or startup costs will find it easier to jot down their revenue. Businesses with more in-depth finances will require a completely different type of bookkeeping.

Profit & Loss Statement

The first thing that you need to do is develop a profit and loss statement (P & L). A profit and loss statement is a ledger for all your revenue and the expenses are subtracted from that revenue. Many profit and loss statement templates are available online or through spreadsheet programs, such as Microsoft Excel.

Profit and loss statements cover extended periods of time. Solopreneurs must log monthly, quarterly, and annual profit and loss statements. These enable solopreneurs to track their ongoing business earnings.

If you have not already done so, set up a business bank account. Avoid paying any personal expenses from your business bank account. Instead, allow yourself to deduct a salary or share of the profits. Use the rest to pay off business expenses. Sometimes, solopreneurs get off to a rocky start. Setting clear guidelines and restrictions for personal spending can help you boost the health of your business.

When it comes to recording your self-employment finances, you can choose between cash and accrual accounting. Cash accounting is a method of recording profits and losses at the time the money is earned or paid. Meanwhile, accrual accounting is when you log your profits and losses at the time of purchase or sale (even if the money has not hit your account).

What Do I do with my Profit and Loss Reports?

You’ll need this information to file your annual tax returns and make your estimated tax payments. Check out the section below for more information.

Self-Employment Tax vs. Income Tax

As a self-employed individual, you may be subject to federal income, state income, and self-employment taxes. In the section below, we will decipher the difference between these tax classifications.

Self-Employment Tax

When wage earners receive a paycheck from their employer, a percentage of the earnings have already been deducted to account for Social Security and Medicare. As a solopreneur, you are responsible for calculating and paying this tax on your own. Currently, the self-employment tax rate is 15.3%. According to the IRS, 12.4% goes toward social security, and 2.9% goes toward Medicare.

The first $128,400 of your “combined wages, tips, and net earnings” are subject to the social security and Medicare self-employment tax percentages. After that, your income is subject to a 0.9% Medicare tax rate.

There are a few tax deductions that go along with the self-employment tax rate. The first is the Self-Employment Tax Deduction. According to the IRS, you can deduct the employer-equivalent portion of your self-employment tax when computing your adjusted gross income. Depending on your earnings, this may help you to qualify for the Earned Income Tax Credit (EITC).

Another deduction you are allotted is the self-employment health insurance tax deduction. This deduction created because of the Small Business Jobs Act.

Federal Income Tax

Solopreneurs are also required to pay federal income tax. Federal income tax rates vary depending on your filing status and gross income. For example, the tax rate for a person who is married and filing jointly will likely vary from someone who is the head of the household. What’s more, a person who earns less than $!0,000 per year is going to have a lower tax burden than someone who earns $100,000 per year. Regardless of your annual earnings, it is important to check the IRS’s webpage to get an idea of the current federal income tax rate brackets.

State Income Tax

Many U.S. states require citizens to also pay a state income tax. These requirements vary from one state to another. As such, it is important to familiarize yourself with local requirements to better understand what your tax burden is going to be at the end of the year.

How to Pay Your Quarterly Estimated Solo Business Tax

If you are self-employed, it is important that you make an estimated quarterly payment to the IRS. To do this, you must refer to the IRS’s Form 1040. This form can be used to compute your estimated tax burden. It is important to note that a new 1040-ES is issued each year. The form provides detailed information about how to compute your estimated quarterly tax payments.

A Few Things to Consider

It’s important to remember that there are many special exceptions to the tax rules. Be sure to read the entire form to ensure that you act according to the general tax rule or else the exception.

Special Rules for Farmers, Fishermen, Household Employees, and High Earners

In order for the IRS to consider you a self-employed farmer or fishermen, two-thirds of your income must come from farming or fishing. If this is the case for you, you must reduce the number of deductions you take on the estimated tax worksheet. What’s more, if you are a household employee, you need to include your household employment tax on your worksheet. What’s more, if your adjusted gross income is higher than $150,000, you can increase the amount of your qualified business income deduction. What’s more, if you only earn money seasonally, you may be able to avoid making quarterly payments during the times when your earnings are reduced.

It’s important to acknowledge these exceptions to the general tax rule because they are a reminder that no two tax situations are the same. Always use the current IRS estimated tax forms to calculate the most accurate estimated tax payments.

Estimated Tax Payment Cut-Offs

You only need to make estimated quarterly tax payments if you have a self-employment tax burden of $1,000 or more. What’s more, no self-employment is subject to an estimated tax payment during the first payment period. You must file for 2210 in order to avoid any tax penalty at the end of the year.

How and When Do You Make a Payment

The first thing to remember is that there are plenty of ways to get your estimated tax payment to the IRS.

Pay by Mail

At the end of the IRS’s Form 1040-ES, there are payment vouchers that can be printed and mailed along with a check or money order. The included payments must be made payable to the “United States Treasury.” They must also include your social security number.

Each year’s 1040-ES form included four payment vouchers. On the right side of each form, there is a small section that reads “calendar year.” This statement is followed by the exact due date of each quarterly estimated tax payment. For example, the four 2019 estimated tax vouchers read “Due Jan. 15, 2020,” “Due Sept. 16, 2019,” “Due June 17, 2019,” and “Due April 15, 2019.”

You will need your prior year’s annual tax return to fill our 1040-ES. If you are struggling to find your prior year’s tax return, you can request a mailed transcript from the IRS. If you go this route, plan ahead. It may take several weeks before you receive your transcript in the mail.

Pay Online

You can also pay online using a variety of electronic payment options. The IRS online payment is safe and secure. What’s more, it offers instantaneous payment confirmation. You may use IRS Direct Pay to transfer money directly from your checking or savings account. To do this, all you need to do is go to IRS.gov/Payments. You can use the same webpage to make a payment from a credit or debit card.

Another option is to make an automatic electronic funds withdrawal. This is an online payment option that is often offered to you through e-file software and tax professionals. It eliminates the hassle of changing webpages just to make a payment.

If you are unable to pay your entire estimated quarterly tax burden by its due date, then you can visit the IRS’s webpage to apply for an online monthly installment agreement. With that said, proper tax preparation and savvy saving should protect you from this sort of situation.

Not surprisingly, the IRS has its very own app. IRS2Go gives you a mobile option for paying your estimated quarterly tax payment via your payment card or bank account.

Pay by Phone

The IRS provides three different phone numbers that you can use to make a payment. Phone payments are made through third-party service providers, including WorldPay US, Inc., Official Payments, and Link2Gov Cooperation.

What if I Miss an Estimated Quarterly Payment

If the tax payment deadline passes and you’ve failed to make a payment, the IRS may penalize you. Don’t wait until the next tax deadline to make up for the missed payment. Penalties are based on the amount of the missed payment and the amount it was overdue. If you missed or underpaid, you would need to file a Form 2210, “Underpayment of Estimated Tax by Individuals, Estates, and Trusts.” This form is used to compute your penalty.

How to Pay Annual Your Self-Employment Tax

Mark your calendars! The official deadline to file your federal tax return is normally April 15. Don’t let spring fever interfere with your filing, most current year tax forms are available by January 31. If you have all your finances in order, you can submit your return and hear back from the IRS long before the end of the tax season.

What Form Do I Need

To file your return, you will need to file Schedule SE (IRS Form 1040). In order to fill out Form 1040, you will need to compute your net profit or loss. The instructions for the form are fairly straight forward. They provide numbered calculations that will help you to calculate your gross taxable income.

Choosing the Right Filing Method

As a taxpayer, you can choose to file in a variety of ways. You may opt to pick up a paper copy of your tax forms and submit them by mail. Alternatively, you may choose to hire a professional tax preparer. Another option is to use a reputable online tax preparation service.

If you are reporting incoming that you earned or lost from a business or sole proprietorship, you will need to fill out a Schedule C or Schedule C-EZ form. Meanwhile, you will also need to file a Form 1040 to report the social security and Medicare tax payments you owe or should have already paid. You are most likely also required to submit an information return.

How to Save Tax Money for Solopreneurs

There are many unique tax breaks for self-employed workers. In the section below, we’ll discuss some of the key most popular self-employment tax deductions.

Self-Employment Tax Deduction

Traditional employers are required to cover half of the cost of Medicare and social security deductions. Since self-employed workers are required to pay the entire portion themselves, they get to claim the employer-required portion as a deduction on their solo business taxes. The self-employment tax deduction is a credit that you need to claim on your Schedule SE (Form 1040)

Health Insurance

If you are self-employment and are not enrolled in an employer-sponsored health care plan, you or your spouse is completely responsible for your health insurance coverage. As such, if you paid for insurance for you, your spouse, or dependents, you may be able to claim some of that as a tax deduction.

Home Office Deduction

The IRS’s home office deduction enables self-employed individuals to claim some of their home expenses as business expenses. To qualify for this credit, your home office needs to take up at least 20% of your house and be your main place of business. If this is the case, you can claim a variety of expenses related to your home, including everything from mortgage interest to home renovation supplies. You can also use the deduction if you rent your home.

Internet and Phone

Some self-employed individuals are hesitant to claim the home office deduction. Yet, they still want to reduce their tax burden. If you use your home internet or phone to conduct business, you can deduct some of the related expenses.

Travel Expenses

If your business takes you on the road, you can deduct your travel-related expenses. To do this, you will need to be keeping excellent records. If you drive a vehicle to conduct business, you can deduct your business trips. Use the IRS’s standard mileage rate or jot down the exact mileage and cost of your trip. In 2018, the IRS’s standard mileage rate was 54 cents.

Retirement Expenses

It’s important to save for retirement. As such, the government does not tax money that is circulated to an IRA or 401K. Consider reducing your tax bill and bulking up your nest egg all in one go.

Wrapping Up

Many of us are predisposed to receiving a W2 and filling out the most basic tax forms. As such, solopreneur tax rules can pose as a unique learning hurdle. Of course, that doesn’t mean they are impossible to do. There are plenty of places to save money as a solopreneur. What’s more, a bit of careful planning and record keeping will have you coasting past all your tax deadlines with ease. If you want to reap the benefits of being your own boss, the slight inconvenience of tax time is a small price to pay.

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