Taxes For The Newly Self Employed

People who earn money from self employment often do not know how to report and pay taxes from self employed to the IRS. Here is information about Schedule C, Schedule SE, and depreciation expenses.

You have begun making a little money "on the side" this year, or maybe you have given up your corporate job to begin freelancing. What do you do about income taxes when April 15th rolls around?

If you have made income over the minimum filing requirement (from all sources) in a year, the IRS wants to tax your income. If some of that income is from services you performed on your own (rather than as an employee), the IRS considers you a sole proprietor and requires some extra tax forms when you file your income tax return. These may include Schedule C - Income/Loss from a business, Schedule SE - Self-Employment Tax, and Form 4562 - Depreciation and Amortization. You can view and print all of these forms from the IRS website.

Schedule C is the IRS equivalent of an income statement or P&L. You will need to file a separate Schedule C for each type business for which you are self-employed (For example, if you earned money as both a freelance writer and as a personal shopper, you will need to file two Schedule Cs). On this form you will report all of your revenue (money paid to you by others) and all of your expenses. When complete, Schedule C tells you your net profit or loss from self-employment. This figure is transferred to both your Form 1040 and Schedule SE.

When you look at Schedule C you will see that there are many categories of expenses you can report. It is important to keep detailed records for each. The IRS will want to see them if you are audited. There are many types of expenses. Some of those expenses are:

· Cost of Goods. If you keep an inventory you must count and record the value (generally, what you paid) of your inventory at the end of the year. This becomes both your ending inventory for one year and beginning inventory for the next. You must also know the value of the inventory you sold throughout the year. A computation gives you the cost of goods.

· Vehicle Expense. If you used your car or truck to produce self-employment income you may apply a standard mileage rate or a portion of the actual cost of running your vehicle to business expenses. A detailed log of expenses and miles driven is helpful in both figuring and proving use.

· Rent and utilities. Any equipment or office space rental related to producing your self-employment income is deductible as an expense. Also, in some cases you can count part of your home as a home office and deduct a portion of your mortgage interest and real estate taxes.

· Office equipment. If you purchased or use equipment such as a computer, fax machine, desk, or file cabinets you may be able to deduct a portion of their expense through depreciation. For both this and the home office expense consult your tax advisor for an evaluation of your situation.

There are other types of expenses you can deduct on Schedule C as well. These include (but are not limited to) office expenses, bank fees, business insurance, legal/professional services, travel expenses, taxes/licenses, and employee-related expenses (if you hire someone to help you).

If you qualify and chose to depreciate some of your equipment or building you will also need to file Form 4562 - Depreciation and Amortization. Items can qualify for depreciation even if you do not use them solely for business. When you use your property for both business and personal use, the depreciation is pro-rated according to how often it is used for business. Some items - equipment and office furniture - may qualify for a Section 179 deduction. This means you can deduct the entire business cost in the first year. If qualified, you can choose to depreciate the item or use the Section 179 deduction (but not both). There are numerous categories of depreciation depending upon the specific item and special rules often apply. Also be aware that when you take a Section 179 deduction or depreciate your property, you have converted part of that property from personal-use property to business-use property. This could have tax consequences for you if you sell the property later on.

The third tax form related to self-employment is Schedule SE. On this schedule you will compute your self-employment tax owed to the IRS. The form will walk you through the computation of the social security tax and Medicare tax you owe as a result of your self-employment. These taxes are higher than those deducted from your pay as an employee. This is because you are paying both the "employee" and "employer" portion of these taxes.

A final note regarding payment of taxes: if you have substantial self-employment income you will need to make quarterly estimated tax payments. As a rule of thumb, if you will owe $1,000 or more in taxes next year AND you expect less than 90% of those taxes to be withheld by an employer, then you should investigate filing form 1040-ES on a quarterly basis. 1040-ES is due by April 15, June 15, September 15, and January 15.

As with all tax matters, there are several exceptions that require special treatment. This article is meant to give an overview of the general tax laws. See a tax advisor about your specific situation and advice on filing your income taxes.

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