Are you self-employed, do you freelance, or do you run a business on the side? You have a complicated tax situation, all stemming from one fact — when you earn a paycheck taxes are not immediately taken out of it.
Many self-employed taxpayers are caught off-guard when tax season arrives. They are stunned to realize how much tax they owe. If you would rather not be one of them, pay attention to these details.
You should receive all your 1099-MISC forms by early February. If you earn more than $600 working for a client or customer during the year, that customer will send you a Form 1099-MISC. Frustratingly, some customers miss the Jan. 31 deadline for issuing 1099s and send them out in the spring — or don’t send them at all. Whether you get a 1099 on time or not, you must report the income to the IRS on Schedule C or Schedule C-EZ. If you neglect to report any 1099 income, the IRS will send you a letter noting the missing income and requesting the corresponding tax payment.
If a customer has botched information on a 1099, tell the customer right away — they may be able to correct the error before sharing the misinformation with the IRS. If it turns out the IRS already has the incorrect information, ask the customer to correct it on your behalf.
If certain requirements are met, you, as a small business owner, have an obligation to send out 1099s to your own vendors. Typically, the threshold for this reporting requirement is $600 or more paid during the year to any one vendor for services rendered to your business. Examples could be legal fees paid to an attorney or services provided by a contractor for repairs. There are several exceptions to this reporting requirement. Consulting a tax professional for assistance with issuing 1099s would be beneficial for accurate and timely reporting compliance. Penalties associated with noncompliance and willful disregard to the rules regarding issuing 1099s can be steep, so take this requirement seriously.
You may also need to report the gross earnings to the state Department of Revenue (DOR) for Business & Occupation taxes — our state’s gross receipts tax. Be sure to check the DOR website for taxation guides to your business’s industry.
As a self-employed taxpayer you can deduct many things. Fifty percent of the Medicare and Social Security tax you pay is deductible. Hardware and software expenses as well as work-related advertising, travel, phone charges, mailing expenses, and office supply purchases may be deducted. When compiling deductions, don’t forget to keep track of your business-related mileage; this can be an especially rich deduction. You can deduct rent you pay to house your business, the cost of books and publications you purchase for it, and legal and professional fees you pay on behalf of it. You may also deduct expenses associated with a home office if you work out of your home, whether you rent or own.
Maybe you pay for your own health coverage. Self-employed taxpayers who do so are eligible to deduct the cost of their health insurance premiums. Also deductible are Medicare premiums you pay for Part B, Part D, and the expense you pay for a Part C (Medicare Advantage) plan or a Medigap policy.
In addition, in 2018 the Tax Cuts and Jobs Act will provide an additional deduction of up to 20 percent of your business income for qualified taxpayers. This deduction has some limitations and complications, but may benefit your small business.
If you accept credit and debit cards as payment, you are sure to receive Form 1099-K. This IRS form reports income from debit card, credit card and third-party network transactions. Your Form 1099-K should arrive in early February. When you get it, confirm its accuracy by checking your gross receipts, payment card records, and merchant statements. See that it reports income generated through all payment avenues (PayPal or similar services, credit cards, etc.)
The income amount reported on your Form 1099-K does not have to be reconciled with the gross receipts you report on Form 1040. This is because adjustments to sales income (such as chargebacks) are not reported on Form 1099-K. Keep documentation handy to support both your income and any deductions you want to claim on your 1040 and your state tax return.
Taxes on self-employment income can be steep. If your unincorporated business is turning a profit, you should be making quarterly estimated tax payments for two reasons. One, your earnings from this venture are not having taxes withheld from them like traditional employment (W-2 wages); and two, your net earnings are subject to self-employment tax — a tax owed in addition to regular income tax that is calculated at a flat 15.3 percent of the net income from your self-employment ventures.
Coping with quarterly self-employment and income taxes may become a little easier if you change your withholding at your regular job. If you (or your spouse) do that, you might free up the money to cover the taxes generated by your small business.
You can also defer taxes by creating and contributing to a qualified retirement plan linked to your business, such as a Solo 401(k) or Simplified Employee Pension (SEP) plan. Your contributions to these plans are tax deductible, and they give you a chance to boost your retirement savings.
If your sideline business has a loss for 2017, that loss is only deductible as a business loss if the IRS characterizes your business as an activity with a profit motive instead of a hobby. Therefore, you should take a look at the hobby loss rules before trying to claim such a deduction.
Jennifer Babcock is a Certified Public Accountant with Cordell, Neher & Company, PLLC, a Wenatchee public accounting firm. She may be reached at 663-1661 or firstname.lastname@example.org.