Tax Preparation Tips for the Self-Employed

income taxIf you are self-employed, your tax situation will be different than that of someone who is an employee. Preparing self-employed taxes can be a bit of a minefield, but you can reduce your tax bill by taking advantage of deductions. Here are some tips for preparing for your self-employment taxes.

1. Keep on top of your paperwork

If you’re self-employed, you’re responsible for keeping your own records, especially your income and expenses.  To take advantage of tax deductions, you’ll need to keep hold of all relevant receipts in case you’re selected for an IRS audit.

2. Decide how you’ll pay

Self-employed individuals must pay estimated taxes based on the amount that you think you’ll owe to the IRS when you file your tax return. Once you’ve worked out your estimated tax, pay it on a quarterly basis to avoid clocking up penalties or interest (which is extremely likely if you leave your estimations until April 15th of the following year). As well as being the safer option, it also reduces the temptation to spend the money that you’ve earmarked for taxes. Remember that this payment is only an estimate, and the amount that you actually owe may be more than you anticipate.

3. Set money aside for taxes

To avoid being hit with a tax bill that you can’t pay, transfer 20 to 25% of all income to a tax account that is used specifically for money that you’ve allocated for paying your tax bills. This way, you’ve got money set aside for paying your self-employment taxes, and you won’t need to hastily borrow money from your savings accounts to scrape the money together.  Because it’s in a separate account, you shouldn’t be tempted to dip into it for other expenses, but if you think you might be tempted, make it harder to access the money by using an account that isn’t directly linked to your checking account.

4. Contribute to an IRA

This is frequently overlooked as a tax deduction, but it can have big benefits. While you can’t pay into a 401(k) if you’re self-employed, paying into a self-employment retirement fund like a SEP IRA lets you save towards retirement and has the added advantage of acting as a tax deduction. If you are a sole proprietor and you receive compensation as personal income, you can contribute up to 25% of your net adjusted self-employment income or business profits.  SEP IRA contributions are usually 100% tax deductible from personal income.

5. Make use of tax deductions

As a self-employed individual, you can claim certain deductions to lower your tax bill. Here are some of the tax deductions that you may be eligible for.

  • The home office deduction. If you work from an office in your home, you may be able to deduct some of the costs of your utility bills, secondary telephone lines (think cell phones and Skype accounts that are being used for business-related calls), and mortgage and insurance payments. Ideally, this office should be separate to your living areas.  For example, it should be in a room of its own rather than just having a workspace set up in the corner of your bedroom.  It makes it easier to determine what can be deducted. IRS Form 8829 is the one that you’ll need to fill in to see if you can take advantage of the deduction.  Before you fill in the form, you’ll need the exact measurements of both your home and your office space, because the percentage of your expenses that can be claimed will be determined by the percentage of your home that is acting as office space. Many people are afraid that claiming this deduction will increase the chances of being audited by the IRS, but don’t let this stop you from taking the deduction if you’re eligible.  The IRS look for a number of red flags before they choose who to audit.
  • Job hunting deductions. If you use job boards or websites to find freelance or contract work and have to pay a membership fee, you may be able to deduct these as job hunting expenses.
  • Unpaid invoices. If clients haven’t paid up, you may be able to write off the unpaid invoices as bad debts, but you’ll have to add the amount(s) to your self-employment earnings total first.
  • Office supplies deductions. Office supplies that are used for your business can be deductible, and this can extend to office equipment such as computers or computer hardware that have recently been bought for business use.
  • Tax Services. Many self-employed people prefer to let an accountant take care of their taxes to save time and avoid the potential problems that may befall you if you make mistakes. If you choose to use the services of a tax professional, you can write this off as a deductible expense.

If your small business is your full-time job and primary income, we strongly recommend that you hire the services of a tax professional to help you prepare your taxes. It’s a fact that more self-employed business owners get audited by the IRS, so you want to make sure you get your tax filing done right the first time.

With that said, there are some terrific online tax products that allow you to file your own taxes and work great even for those who are self-employed. Check out our reviews of TurboTax, TaxACT, and H&R Block for some detailed information about our favorite online tax products.
(photo credit: alancleaver_2000)

  • gina

    It has definitely been more of a challenge to have discipline to pay my own taxes quarterly, and to save up myself for retirement. But, as long as you are organized and careful, it can work out! DON’T be tempted to use money that should be set aside for taxes–it may come back to bite you!

    • Sally Aquire

      I agree about the discipline. Remembering to set aside money for taxes came as a bit of a shock for me in the beginning but it’s funny how quickly you get used to things when you have to!

  • Keith Morris

    I had earmarked $5,000 to pay taxes for 3 months of self-employment work and went the entire year without touching that money. Unfortunately, I counted my chickens JUST before they hatched:

    • Sally Aquire

      Ouch! That would have been a nightmare if there had been no emergency fund to tap into.

      • Keith Morris

        Well, I suppose I could have returned one of the computers, but my iMac is way too pretty to be considered for that option. ;)

  • David/Yourfinances101

    The paperwork thing and the quarterly payments seem to be the biggies here. I got bit in the you know what a few years back by not paying quarterly. It does add up quickly.

    And obviously, keep track of all paperwork.

    I’d imagine the IRS has a special eye out for the self-employed

    • Sally Aquire

      That wouldn’t surprise me, especially if you were to have a big turnover in a particular year.

  • Kendra

    I’m going to pass these tips on to my husband. This is his second year being self employed.

  • Karmella

    I am constantly reminding my brother about the paperwork and quarterly payments. I’d suggest enlisting help to keep yourself on track and accountable for those things.