When it comes to “being your own boss,” Americans seem to have it covered. About 15 million people in the U.S. are self-employed, or 1 in 10 workers according to the Bureau of Labor Statistics. But when tax season rolls around, many hire tax professionals and shell out return preparation fees.
That’s all well and good, but if you’re self-employed and looking to save, DIY-ing your taxes — or using paid tax software — might be your best and cheapest filing option, especially if you’ve got minimal expenses. You’ll need to track expenses and calculate deductions even if you hire a tax professional to file on your behalf, so if you’d like to cut down on preparation fees, consider giving it a shot on your own first. Here’s what you need to know if you plan to try it out.
The Skinny On Tax Software
If you’re comfortable with online filing, many tax software companies offer specialized services for small business owners. “You really don’t have to be a tax expert because the program walks you through and asks you questions,” says Barbara Weltman, author of “J.K. Lasser’s Small Business Taxes 2018.” Simply gather your forms, relevant business expense receipts and other financial documents, then jump right into the software of your choice and follow its prompts. If you’ve got questions, tax software companies generally offer tax-related support via phone or chat. You can also check out the IRS self-employed online tax center.
How to Treat the Home Office Deduction
“More than half of all businesses in the U.S. are home-based, so it’s not going to be something startling to the IRS to see a home-office deduction,” says Weltman. In fact, the IRS’ stance is if you have a space you use regularly and exclusively for business, you should take advantage of the home office deduction. If that idea gives you pause, know that taking the home office deduction doesn’t automatically mean you’ll get audited.
The key to claiming any deduction is making sure you follow the rules. The IRS outlines them all here, but one thing to be sure of is that your office space is your principal place of business and used regularly and exclusively for work. That means it doesn’t perform double duty as a guest room or anything else. (It doesn’t necessarily have to be a separate room, though. A corner of your bedroom with a desk, computer, and files can work as long as you use it exclusively for business.)
In calculating the deduction, you have two options. One is to claim the simplified home office deduction, where you deduct $5 per square foot of your home office (up to $1,500 and 300 square feet). The second is to calculate all of your actual expenses, which includes both direct and indirect costs. For indirect costs, items like mortgage interest, taxes, maintenance costs, insurance and utilities, you must determine what percentage of the total cost was used solely for your business space. Only that portion is tax deductible – not the entire cost.
And, as a final note, regardless of which method you choose, your deduction is limited to your net business income. That means, if you experienced a business loss for the year, the home office deduction will not decrease your tax liability further.
The Lowdown on Self-Employment Tax
There’s no doubt being self-employed is a little more complicated when it comes to taxes than working for a traditional employer. As a self-employed individual, you have to calculate and pay the self-employment tax (SE), which covers your tax requirements for the Federal Insurance Contributions Act (FICA). FICA funds Social Security and Medicare. When you work for a traditional employer, your employer covers half of the tax for you. You, of course, pay the other half.
But, when you’re self-employed, you are on the hook for all of it since you’re both the employer and the employee. The SE tax is 15.3 percent of your self-employment income and is separate from the federal income tax. To cover that added cost, it’s worth planning out your cash flow for the entire year and understanding “that you’re not just paying regular income tax — that you’re paying this additional amount of 15.3 percent,” says Andrew Oswalt, tax analyst at TaxAct.
Get Your Quarterlies Straight
You’ll generally need to pay quarterly estimated taxes if your tax liability for the year is $1,000 or more. Since the IRS expects to receive tax payments as you earn your income, you’ll likely need to make estimated tax payments four times a year — in April, June, September, and January of the following year. The first payment for the current year is due the same day your last year’s tax return filing deadline. And even if you file an extension, you’ll still need to pay that same day.
To avoid feeling strapped for cash when each payment deadline comes around — and to avoid the steep underpayment penalties if you don’t pay enough throughout the year — it’s important to account for all of your tax responsibilities ahead of time and set that money aside. “When you don’t pay quarterly tax payments, or you don’t pay enough tax by the due date of each payment period, you may be charged a penalty at the end of the year, even if you’re due a refund,” says Holly Reisem Hanna, founder of The Work at Home Woman. “Be sure to mark your calendar for the quarterly tax due dates.”
The best way to plan for your quarterly payments is to follow the estimated tax safe harbor rule, which says to pay 90 percent of the tax shown for the current year’s return or 100 percent of what you owed the previous tax year. “For most people, it’ll be 100 percent of what you paid the previous tax year,” says Weltman. If you are married and had an adjusted gross income over $150,000 in the previous tax year (or over $75,000 if married filing separately), you’ll likely pay the lower of two options. TaxAct can help you quickly calculate the amount you owe and set up quarterly payments, so you’re covered throughout the year.
With Hayden Field. This blog by Jean Chatzky is in partnership with TaxAct.