I’ve been a self-employed taxpayer for most of the last 15 years. Even when I did work for a traditional employer and received a W-2 form, I still freelanced on the side and earned self-employed income. I’ve had an LLC since 2007, when I decided to make things a little more “official.” You might be an independent contractor or have a different type of business structure, but if you're earning self-employment income of some sort then this information will be helpful for you.
For the most part since forming the LLC, I’ve hired someone else to do my taxes. It’s much easier than using even the best tax software. But even when you hire someone else to handle the forms and the filing, there’s still plenty of room for error as a freelancer.
These days, tax time goes fairly smoothly for me, but I’ve made my share of tax mistakes before. Hopefully, these self-employed tax tips will help you avoid some of the issues I experienced in the past and understand how to manage your money better.
7 tax tips for the self-employed
When taking care of your taxes, it’s a good idea to be organized and plan ahead. Realize, too, that as you become more successful, your chances of receiving a tax refund are fairly slim. Here are some things to keep in mind.
1. Set up separate accounts
First of all, it’s just good practice to have separate personal and business accounts. When I began as a sole proprietor, I didn’t have separate accounts, and it was painful to go through and identify which items were for business and which weren’t.
With separate business accounts — no matter your business type — it’s much easier to remain organized. When you have separate accounts, especially if they’re integrated with accounting software, it can make things much easier for you or your accountant to see exactly what business income came in and went out. Plus, it makes things nice and tidy in the event that you’re audited.
Keep your business accounts separate from your personal accounts, and things will be smoother overall.
2. Plan for quarterly payments
At a traditional job, your employer automatically takes out taxes from each of your paychecks. But as a self-employed person, you’re responsible for making estimated tax payments during the year.
The IRS likes you to pay quarterly, so it’s a good idea to make it happen. The first couple of years I was self-employed, I didn’t make quarterly payments. Unfortunately, in some cases, you can end up paying a penalty if you don’t make those quarterly payments.
According to the IRS, if you owe $1,000 or more when you file your annual tax return, you could be charged an underpayment penalty. You can avoid this, however, if you pay the smaller of:
- 90% of the tax owed in the current year
- 100% of the previous year’s tax bill
You can make quarterly tax payments online, or you can mail a check. In the past, I’ve made quarterly tax payments with a credit card to get the rewards (though there is an added processing fee when you use a credit card). This can be one way to reduce the sting.
What if you can’t afford your taxes? Well, in the past, I’ve used the payment plan offered by the IRS. You’ll pay a fee, but it might be less than the interest you’d pay on a loan.
3. Put aside money each month
One of my best self-employed tax tips is to set aside money each month to make your quarterly tax bill more manageable. In my first year as a self-employed filer, I didn’t make quarterly payments or set any money aside. When I finished my tax preparation and saw the bill, I was quite surprised; I owed much more than I could afford to pay at that time.
When you work for someone else, they pay half your FICA taxes (that is, your Social Security and Medicare taxes). But if you’re self-employed, you pay both sides of FICA taxes. That can mean a bigger tax bill, even if your marginal rate is fairly low.
After that first year of freelancing, I began setting aside a certain amount of money each month for taxes. Originally, I multiplied my tax bill by 15% to account for a potential increase in taxable income and then divided that by 12. So, if I owed $10,000 one year, I’d add another $1,500 to the total. Then, I’d take that $11,500 and divide it by 12 to set aside $958.33 each month in a dedicated high-yield savings account.
Once it was time to make my quarterly payment, I’d pay the bill with a credit card, collect my points, and use the money amassed in my savings account to pay off the credit card before the balance began accruing interest.
4. Don’t forget about state taxes
Once I had my quarterly taxes squared away at the federal level, I realized I had forgotten about state taxes. If you live in a state that collects its own income tax, you could find yourself in trouble with another entity.
Some states that collect income tax don’t do so throughout the year. Instead, they just expect you to pay at tax time. I was super excited in my second year of self-employment to see that I’d managed to arrange matters so that I owed a small amount in federal taxes after the reckoning. Success! My plan for quarterly payments had worked out well.
Unfortunately, I still had to come up with another couple thousand dollars in state taxes. Check your state tax laws and adjust the amount you set aside monthly to account for state taxes. In my case, I let the account grow throughout the year and make a bigger payment at tax time since quarterly taxes aren’t required by my state. This allows me to keep my money longer, allowing it to earn a little more interest before I send it to the state.
5. Think about your business structure
Understand the tax implications of your small business structure. When I was a sole proprietor, I just needed to fill out a Schedule C form. However, when I formed an LLC with my then-husband, I had to start filing a K-1 form that set forth the finances of the business. With an S-Corp., you also need a K-1 form.
Additionally, depending on your business type, you might need to file your business tax forms in March rather than April. That can put a crimp in things if you aren’t ready to file.
Right now, I’m looking into changing my tax designation to file as an S-Corp. The advantage here is that it’s possible to set it up to pay myself a salary. Later, if I want to take a distribution from the company, in addition to the salary, I won’t have to pay FICA taxes on the distribution. I’d still have to pay FICA taxes on my salary and income tax on the distribution, but it’s one way to reduce your tax liability.
However, talk to a tax professional before making any changes to your business structure. You don’t want to manage the process poorly and end up with a penalty.
6. Keep a folder
One of the most useful self-employed tax tips is to set up a folder to stay organized all year. This can be a hardcopy folder or an encrypted folder you keep on your desktop or in the cloud. Every time you have a business expense or other tax-deductible cost, put it in the folder immediately. If you have a digital folder, snap a picture of your receipt and file it away properly.
Another trick I use is to create labels in my email for different receipts. If I receive a receipt for business software I bought online or a renewal for a domain name, I label it, and it goes into the appropriate place in my email. Each year, I grab all of that information, and it’s easily available for my accountant or on hand for an audit.
When you have a system that keeps you organized all year, it’s much easier to prepare your taxes and claim all the tax breaks that are available to you.
7. Consider hiring someone
Finally, consider hiring someone to prepare your taxes. While doing your taxes yourself is the cheaper option, hiring a professional takes away a lot of the stress at tax time. Plus, they may know of additional deductions or credits you may be eligible for.
In my case, I simply provide my accountant with relevant bank statements, my net profit and loss statement, and other appropriate documentation, and he handles the rest. In some cases, if you have an accounting software program, you might even be able to just turn that over to your accountant and keep your receipts for backup.
Choose an accountant that understands your tax situation. My accountant specializes in freelancers and those who run online businesses, so he knows the landscape. It’s been very helpful in the years I’ve used him.
Bonus tip for retirement planning
Consider setting up a SEP IRA to save on taxes and save for retirement. A SEP IRA allows you to deduct your contributions, and the limit is much higher than what you’d see with a traditional or Roth IRA. For example, for tax year 2023, you can contribute up to 25% of compensation or $66,000, whichever is less.
Any business is eligible to set up a SEP IRA, including sole proprietorships. These plans are easy to establish, and some online brokers and robo-advisors, like Acorns, offer SEP IRAs.
What expenses can I deduct for self employment?
Although many people are aware of the home office deduction, you may not know of other business-related expenses you may also be able to write off:
- Cost of goods you sell
- Business startup costs (including business assets and improvements)
- Business use of your home (mortgage interest, insurance, utilities, repairs, and depreciation)
- Business use of your car
- Interest on business loans
- Employee pay and retirement plans
- Rent expense
- Taxes (various federal, state, local, and foreign taxes)
To make the most of your tax credits for your office space, office supplies, and other necessary expenses, consider speaking with a CPA or tax professional so that you stay within the boundaries of what is legally allowed.
What is the difference between Schedule C and Schedule C EZ?
Schedule C EZ is designed to be an easier, less-detailed form to fill out. You can use Schedule C EZ if you have less than $5,000 in business expenses, no employees, don’t deduct the business use of your home, and meet other criteria.
Is there a standard deduction for self employed?
You can still claim the standard deduction on your taxes, but there isn’t a special standard deduction for the self employed. However, you can claim a self-employment tax deduction if you meet the requirements.
What income is exempt from self-employment tax?
If you make less than $400 in a year, you don’t have to pay the self-employment tax.
Self-employed business owners can find this type of venture very rewarding, but it also comes with extra work at tax time. If you follow these self-employed tax tips, you’ll be more likely to keep your sanity — and reduce the chances that you owe more than you can afford come April.