Being you own boss is an idea that appeals to many people. You set your own hours and perform work that interests you. Lots of folks go into business for themselves for those very reasons without considering all the implications of self employment. Being your own boss often entails necessary tasks and functions that have nothing to do with the work you enjoy. Filing and paying taxes probably leads the list. This article will provide insights into the federally required taxes and forms that go with them.
Definitions of Self Employment
First, you need to understand how the Internal Revenue Service defines self-employment. You may think that it requires renting office or work space, having a business name and even hiring employees. Although those things may occur, they are by no means required in order for the IRS to consider you self-employed. In fact, self-employment forms and taxes may be required even if you are employed by someone else and simply run your business on the side.
The IRS uses the term "independent contractor" to define self employment, and has a number of guidelines to differentiate between an independent contractor and an employee. Generally, if a buyer does not withhold income, Social Security and Medicare taxes, nor do they pay unemployment tax on the wages paid to you, you are considered an independent contractor. Therefore, you are self-employed.
The IRS uses three categories to define the relationship. They are behavioral (who controls when and how the work is performed); financial (how payment is made and whether or not expenses and supplies are reimbursed); and the type of relationship that exists (signed contracts and types of benefits such as health insurance and sick pay).
W-9's and 1099's
If you are an independent contractor, the buyer will ask you to sign a W-9 form. This is the "Request for Tax Payer Identification and Certification." It verifies your tax payer identification number. This number can be either your Social Security number or an EIN (employer identification number).
Additionally, if your client pays you in excess of $600 annually, they will issue a 1099 form. This is the document for reporting payments to the IRS. The buyer is required to provide this form to you by Jan. 31 showing all payments made to you for the prior year.
What Taxes Must You Pay?
Assuming you are self-employed and liable for taxes, which ones must you pay? First, you are required to pay self-employment tax. This tax is your portion of Social Security and Medicare taxes. The SE tax is based on the amount you claim as total income, and comes in two parts. As of tax year 2008, the tax rate for the Social Security portion is 12.4 percent and the portion for Medicare is 2.9 percent.
There is a maximum threshold in place, however, on how much of your earnings are taxable. In tax year 2008, only the first $102,000 of income is taxable at the 12.4 percent rate. All of your earnings are subject to the 2.9 percent portion.
You are also responsible to pay personal income tax and report it on form 1040. Your tax rate is dependent upon how much you make in your business or, if it's a part-time venture, on the combination of your salary and self-employment earnings.
Schedule SE
You must pay self-employment tax and file Schedule SE if you have net earnings from your self-employment of $400 or more (excluding church employee income). You must file Schedule SE if you earn $108.28 or more as church employee income, as of tax year 2008.
Schedule SE begins with a flow chart and series of questions to determine whether you must complete the Short Schedule SE or the long version. If the total of your self-employment income exceeds $102,000, you must complete the long version. If it is less than that amount, the flow chart on Schedule SE will walk you through the process in determining which version to file. Schedule SE will help you calculate your tax liability and provides direction for the placement of these figures on your form 1040.
Regardless of which version you must complete, you must first calculate your net profit or loss. This is done on Schedule C (profit or loss from business) and Schedule K-1 (partnership income).
Schedule C
For the self-employed, Schedule C is critical to determine your net profit and makes allowances for subtracting normal business expenses. The key word is "net" income. You are only obligated to pay tax on the profit you make, not on every dollar you receive. If you had absolutely no business expenses during the year, then every dollar you made is taxable.
First, if you manufacture a product, the cost of goods required to make that is deductible.
There also are a number of business-related expenses that can be deducted on Schedule C. Some of these include advertising, business vehicle-related expenses, depreciation of equipment, commissions and fees, office expenses, rent or lease, supplies and repairs and maintenance. Additionally, if you work out of your home, you may deduct expenses for the business use of your home.
Form 1040-ES
The federal government works on a pay-as-you go system for the self-employed. You must pay the self-employment and income taxes that you owe as you earn the money. Estimated payments are required when your tax liability is $1,000 or more. The general rule for 2009 is as follows: If you owed taxes in 2008, then you may be required to pay estimated taxes in 2009 if both of the following are true: you anticipate that the taxes you owe (combined income and SE) exceed $1,000 and your withholding and credits for 2009 will be less than either 90 percent of the tax shown on your 2009 form 1040 or 100 percent of the tax shown on your 2008 form 1040, whichever is smaller. You must pay these taxes on a quarterly basis.
