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A Quick Tax Guide for Self-Employed Individuals in 2021

A Quick Tax Guide for Self-Employed Individuals in 2021
Ines Zemelman, EA
02 September 2021

We have all thought about being self-employed: you get to work for yourself, choose which path to take, wear what you want, and so on. Many people found success through entrepreneurship, and if you put your mind to it, you can turn your dream into reality.

However, freedom comes with a lot of responsibilities and expenses. Filing taxes as a self-employed individual can be complicated, especially if you don't know what you're doing. A mistake in your freelance tax form can result in penalties and fines from the IRS.

Unlike regular employees, self-employed individuals have to keep track of their income, calculate their tax liability, and pay it on schedule themselves. The pay might look bigger compared to your old desk job, but you need to set aside a portion of your income to cover your tax obligations.

To get you started, here's a quick guide to filing taxes when you are self-employed.

What is self-employment?

Self-employment is an all-encompassing term that includes many types of non-traditional employment, including part-time side gigs, full-time freelancing, partnerships, and sole proprietorships. According to a Pew Research Center report, about 16 million Americans are self-employed.

For tax purposes, The IRS considers you self-employed if you meet any of the following conditions:

  • You operate a trade or business as a sole proprietor or an independent contractor
  • You are a member of a partnership that operates a trade or business
  • You are in business for yourself (including part-time ventures)

Most employees have their taxes automatically deducted from their paychecks. However, self-employed individuals have to manage their tax obligations themselves. They are expected to pay self-employment tax on top of their income tax.

What are my tax obligations?

Self-employed individuals must pay a self-employment tax as well as an income tax if their net earnings from self-employment exceed $400. You'll also need to file an annual return and pay estimated tax every quarter.

What is self-employment tax?

Self-employment tax refers to the Social Security and Medicare taxes that individuals who work for themselves have to pay. It is similar to the Social Security and Medicare taxes that are withheld from the pay of wage earners.

For most regular earners, their Social Security and Medicare taxes are split between them and their employer and automatically withheld from their paychecks. However, since self-employed individuals work for themselves, they have to shoulder and pay the full 15.3% tax.

What is the estimated tax?

Since self-employed individuals, including independent contractors, freelancers, and small business owners, don't have their taxes automatically withheld from their earnings, they need to pay taxes quarterly. This quarterly payment is called the estimated tax.

Estimated tax allows you to pay the federal government taxes as you receive income, instead of having to wait until the end of the year. Since the payments are split into four chunks, you don't end up with a huge bill at tax filing.

What forms do I need to use?

Form 1040 (U.S. Individual Income Tax Return) is used to file an annual income tax return. To report your self-employment taxes, attach a Schedule SE (Self-Employment Tax) to your Form 1040.

Use Form 1040-ES (Estimated Tax for Individuals) for your quarterly estimated tax payments. Make sure to keep copies of your financial documents as you will need the previous year's return to fill out this form.

To avoid any mistakes on your tax return, you may want to consult a tax professional. You could end up paying hundreds or even thousands of dollars in fines and penalties if you're not careful.

How do I reduce my tax liability?

Self-employed individuals have to shoulder many extra costs that affect their earnings. However, you can take advantage of self-employed write-offs and deductions to reduce your tax liability.

For instance, you can write off half of your self-employment tax when calculating your income tax. The IRS considers the employer-equivalent portion of your self-employment tax as a business expense.

If you work from home, you can also deduct the cost of your home office space as well as its upkeep, whether you rent or own your home. If your home office takes up 25% of your home, a quarter of your power bill becomes tax-deductible. Office supplies and equipment related to your business can be deducted from your taxes as well.

How to file self-employment taxes?

Filing taxes if you're self-employed can be tricky, and you could incur fines and penalties if you make mistakes on your return or accidentally underreport your income. 

If you're not sure about your next step, contact our tax experts at TFX. With our team of specialists, you will never have to worry about mistakes on your tax return.

Ines Zemelman, EA
Founder of TFX