Common Tax Issues for the Self-Employed


Federal income taxes are collected under a “pay as you go” structure. Ideally, this means that a portion of your income is taxed at the moment it is earned. Sort of a drive-thru earning system. You tell the voice in the box how much you want, they give you a little less than that at the window and away you go.

If you work for wages, you simply advise your employer at what rate you wish to be withheld at by using Form W-4, Employee’s Withholding Allowance Certificate.

If you are self-employed, then it is up to you to ensure that not only are the appropriate amounts are being set aside to cover your taxes, but that estimated tax payments are being made to the IRS on a timely basis as well.

Additionally, since you likely have a horde of business expenses, you need to have a good understanding of what you can and cannot deduct. Business use of your home? Good deduction. Vitamin supplements for your touring one man body building spectacle? Nice abs, but sorry.

Self-employed individuals are required to set money aside in order to offset their taxes. This is a challenge. Not only are federal taxes due, but you also must set aside a bit more for Self-Employment tax, reported on your Schedule SE along with your 1040 tax return. Self-Employment taxes are made up of Social Security tax as well as Medicare.

So when does the IRS require that estimated tax payments be made?

Publication 17, sort of the Federal Income Tax bible for individuals, sets out the following guidance.

In most cases, you must pay estimated tax if both of the following apply:
1. You expect to owe at least $1,000 in tax for the current year, after subtracting any withholding and refundable credits you may be entitled to, and…
2. You expect your withholding and refundable credits to be less than the smaller of
a. 90% of the tax to be shown on your current tax return, or
b. 100% of the tax shown on your previous year return.

As long as you are at least moderately successful in your business, you generally will accrue enough gross earnings to yield $1,000 in tax due. If so, you must make estimated tax payments.

Estimated tax payments are made on a quarterly basis, and the IRS will provide you with a 1040-ES voucher for you to send in along with an estimation of your taxes. IRS Publication 505, Tax Withholding and Estimated Tax, is a helpful resource that will assist you with calculating your payment amount.

When you file your taxes, the money you have contributed in on an estimated basis will then be used against any tax liability. No, your money does not generate interest as it sits with the IRS. But on the other hand, failure to make your estimated payments when you are required will cause the IRS to assess a penalty against you.

The IRS allows for multiple business deductions. These deductions reduce your gross earnings and lower the amount of income you ultimately have to pay tax on. You should be filing a Schedule C, Profit or Loss from Business, to show these deductions.

Among the items you are allowed to deduct are advertising costs, vehicle expenses (You must choose between a standard mileage cost or actual expenses – keep good records!), office expenses, supplies such as machinery or equipment, and your travel, meals and entertainment, subject to a certain percentage.

Don’t stretch these expenses too thin. Constant losses on paper raise the eyebrow of the IRS, as do the ever popular ‘Other’ deductions that are reported on Line 27 of the Schedule C. Anything that goes on this line must be explained on the form, and no, sperm donation does not qualify as a “depletion” expense.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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