Whether you have a small side hustle or run your own biz, you have to pay self-employment taxes. Sorry, it's true. And the process is different from paying taxes on your regular paycheck when you work for someone else.
Give me the details on how to file self-employment taxes.
The US tax system is pay-as-you-go, meaning you pay taxes as you earn income. If you’re a regular employee at a company, your employer automatically deducts some of your earnings from your paycheck for Social Security and Medicare taxes. These are often referred to as FICA taxes, which stands for the Federal Insurance Contributions Act.
If you’re self-employed as a freelancer, contractor, or entrepreneur, you most likely don’t have taxes withheld from your pay throughout the year. That means you’re responsible for reporting your own income and paying taxes on it. DIY style. If your net profit is at least $400, you’ll need to pay self-employment tax — which specifically refers to those FICA taxes — as well as income tax.
Other taxes you might be required to pay as a business: sales taxes, use tax, and payroll taxes on employee salaries.
How to file self-employment taxes step 1: It's classified.
When it comes to how self-employment taxes are reported (and who pays them), there are some key differences based on the type of business entity. Generally, you’ll fall into one of the following categories:
Sole proprietorship: You are the only owner of an unincorporated business. If you’re self-employed as a contractor, freelancer, or have a side gig, you’re likely a sole proprietor.
Partnership: You and at least one other person do biz together and share in the profits. Go team.
LLC: Aka a limited liability company. It’s made up of members, which can be individuals, businesses, or even other LLCs. You can also be the only member of an LLC. The exact rules for how they work depend on your state.
C-corporation: A corporation is owned by shareholders and considered its own tax entity. Owners of a C-corp are responsible for paying taxes on the business income in addition to their own personal income.
S-corporation: Instead of paying taxes as a single entity, owners of an S-corp report company revenue as personal income.
How to file self-employment taxes step 2: Mark your cal.
You'll file a tax return by Tax Day in April, just like everyone else. But you'll likely have to make tax payments on your profits throughout the year, too.
Generally, you're expected to pay quarterly estimated taxes if you think you'll owe at least $1,000 in taxes for the year, says Lisa Greene-Lewis, a Certified Public Accountant and expert for TurboTax. (Psst…this calculator can help you figure that out.) Those quarterly payments are usually due on April 15, June 15, September 15, and January 15 of the following year. You can pay your quarterly taxes by mail or online.
To figure out how much you owe, total your estimated business income for the year and deduct your business expenses. That’s your net income. Then calculate how much you owe total. Divide by four to get your estimated quarterly payments. You can use the worksheet attached to Form 1040-ES to help you crunch the numbers.
If you miss a deadline or underpay, you might have to pay penalties on top of your tax bill. So try to make accurate estimates. One strategy is to overpay a little as an insurance policy. You can also look up last year's return and pay at least that much again. The IRS says most people can avoid underpayment penalties if they've paid at least 90% of their tax bill or 100% of the previous year's taxes.
Lewis says there’s a way to avoid underpaying your taxes if you don’t earn your self-employment income evenly in every quarter: “The IRS knows that the self-employed typically don’t receive their income evenly throughout the year, so they allow you to 'annualize' your self-employment income to avoid penalties for missing a quarterly estimated tax payment if you didn’t earn income in a particular quarter.”
For example, if you made most of your money around the holidays with a seasonal side gig, you could recognize those earnings in Q4 instead of divided evenly over four quarters.
How to file self-employment taxes step 3: Get strategic.
The best way to lower your self-employment tax is to maximize your business expenses, Greene-Lewis says. “You can deduct expenses directly related to your business, so don’t hesitate to deduct startup costs, computer and other equipment, your home office, and even your car.”
For example, you might be able to deduct business equipment worth up to $1,050,000. So if you’ve been thinking about getting a new laptop or phone for work, buying it by December 31 can help lower your taxes for the year. If you use your car 50% or more for your business, you might be able to deduct vehicle expenses, too.
There are also generous rules for retirement savings. You can contribute up to 25% of your net income (or $58,000 for 2021 and $61,000 for 2022, whichever is less) to a SEP IRA and then deduct those contributions. And you have until April 15, 2022 (October 15, 2022, if you get an extension), to make contributions toward the 2021 tax year.
So write down any and all deductions you think you may be able to take. Then buckle up for step four.
How to file self-employment taxes step 4: File away.
POV: it's tax season, and you're ready to file your tax return. Here's what to do next.
1. Figure out if you need to file. Gather all your invoices, 1099s, and receipts, and use them to total your income and expenses for the year. Subtract expenses from your income to get your net earnings. If you're left with more than $400, you need to fill out a tax return. If you made less than that, or your business lost money, you may not need to file unless you meet certain special requirements.
2. Consider a tax ID. You can use your Social Security number as your tax ID number, so this move is optional. But some biz owners might prefer to get a separate ID (it’s free) so they can open business bank accounts and apply for business licenses. Businesses with employees are required to set one up.
3. Fill out the right forms. First, you’ll need to complete a Form 1040. Plus a Schedule C, where you report your biz profits and losses, and a Schedule SE, where you calculate your self-employment taxes (using the deets from your Schedule C). Using tax software like TurboTax or TaxAct can make the process easier.
4. Submit your return. Time to wrap up. If you ended up under- or overpaying your estimated taxes throughout the year, it’ll be reconciled at this point. If you paid too much, you will get money back in the form of a lower tax bill or refund. If you didn’t pay enough, be prepared for penalties. Then make a plan to avoid this mistake next year.
Figuring out how to file self-employment taxes for the first time can feel overwhelming. Staying organized and on top of deadlines make the process smoother. If you need a little extra hands-on guidance, consider hiring a tax pro.