Saving taxes – a guide for the self-employed

For people who are self-employed, being well-versed in taxation basics is always worth­while, par­tic­u­lar­ly because the right knowledge helps you save a lot of money. What taxes need to be paid, and how they are reduced, depends on the form of self-em­ploy­ment, as there are different tax de­duc­tions for business owners and sole pro­pri­etors or free­lancers.

In this text, we will address and clarify the most important tax questions: What exactly can traders and free­lancers deduct from their taxes? Are there other rules for business owners? We provide an overview of what taxes can be incurred, and how self-employed people can save in our 10-step guide to tax.

Free­lancer, sole pro­pri­etor, or business owner? One of the most important questions that arises when starting a business is what category of self-em­ploy­ment you fall under. It is also important because it is also de­ter­mines which taxes are generated and how you can save money as a self-employed person. The following section explains how different in­de­pen­dent work fields are dis­tin­guished from one another.

In the USA, you can be taxed by the federal and/or state gov­ern­ment as either a free­lancer/sole pro­pri­etor or a business owner if you are self-employed. As a business owner, you are liable to pay business taxes, including income tax, estimated taxes, self-em­ploy­ment tax, em­ploy­ment taxes, and excise tax. If you are the sole pro­pri­etor of your business or trade, you are an in­de­pen­dent con­trac­tor, or you are a member of a trade or business part­ner­ship, you are required only to pay self-em­ploy­ment tax, as well as income tax. As a free­lancer, you also only have to pay self-em­ploy­ment tax, con­sist­ing of social security and Medicare taxes, as well as income tax.

As a self-employed person, you need to file your annual tax return and pay estimated taxes on a quarterly basis. It is important to work out your net profit or net loss for the year before you begin filing your tax returns, so that you can find out whether you are required to pay both self-em­ploy­ment and income tax (in some instances, it is not a re­quire­ment to pay income tax on annual earnings of $400 or less). You will then also be able to discern which forms you are required to complete and file.

What exactly is a free­lancer? A free­lancer is a self-employed person who works for different employers for different lengths of time. They rarely have a fixed em­ploy­ment re­la­tion­ship, instead accepting orders and contracts from companies and customers and per­form­ing them on a fee-paid basis. Some work in­de­pen­dent­ly and others are rep­re­sent­ed by a freelance agency. In terms of taxation, the IRS des­ig­nates self-employed people as in­de­pen­dent con­trac­tors. It is important to be able to identify yourself as such, and ensure that any contracts you sign or dockets you receive include this title – some employers will attempt to cat­e­go­rize you as an employee or vice versa, and this can lead to problems when filing taxes later down the line.

How about a sole pro­pri­etor? A sole pro­pri­etor owns an un­in­cor­po­rat­ed business by them­selves – basically a free­lancer who has their own business operation rather than one who is rep­re­sent­ed by an agency. You cannot be con­sid­ered a sole pro­pri­etor if you are the only member of an LLC and treat it as a cor­po­ra­tion.

To un­der­stand how to save on taxes as a self-employed person, you must know which taxes you are required to pay. Here is an overview of the most important tax cat­e­gories that can be applied to self-employed people.

Income tax

Re­gard­less of whether you are a self-employed person, or an employee, everyone is obliged to pay income tax. This tax relates to the taxable profit made by a self-employed person (annual surplus). This is often the most important tax for the self-employed, as many company expenses can be deducted from income tax. If you can reduce your taxable profit, you reduce your tax liability. When filing for income tax, you will need to submit form 1040, U.S. In­di­vid­ual Income Tax Return, and either Schedule C (form 1040), Profit and Loss from Business, or Schedule C (form 1040) Net Profit from Business. If you operate more than one venture, you must submit a C form from each revenue source.

Estimated taxes

Estimated taxes are ad­di­tion­al income taxes that must be paid for any ad­di­tion­al income such as interest, dividends, alimony, capital gains, prizes, and awards. Sole pro­pri­etors and free­lancers must pay estimated tax if they predict their tax payments to be more than $1000. Estimated tax can be worked out using form 1040-ES. Estimated taxes are paid quarterly.

Self-em­ploy­ment (SE) tax

This is a tax which combines social security and Medicare taxes and deducts them from your net income. SE tax is not paid by those that are tra­di­tion­al­ly employed, as those taxes have already been au­to­mat­i­cal­ly deducted. SE tax means that self-employed people can also avail of social security benefits, such as re­tire­ment benefits, dis­abil­i­ty benefits, survivor benefits, and Medicare (hospital insurance) benefits. SE tax must be paid by those self-employed people whose earnings exceed $400, or those who obtained a church employee income of $108.28 or more. The SE tax rate is currently at 15.3% of your income. If you are liable to pay self-em­ploy­ment tax, then you must fill out form Schedule SE which is then filed with form 1040.

Federal un­em­ploy­ment tax

Along with state un­em­ploy­ment taxes, this tax goes towards providing un­em­ploy­ment benefits to people who have lost their jobs. You will need to submit form 940, Employer’s Annual Federal Un­em­ploy­ment (FUTA) Tax Return.

Excise tax

Excise tax, similar to sales tax, is a levy applied to specific consumer goods. Good examples include luxury items or con­tro­ver­sial products, such as cig­a­rettes or alcohol. Unlike sales tax, excise tax is a flat tax applied to the product before the purchase price, rather than a per­cent­age of the sale price.

As a business owner, sole pro­pri­etor, or free­lancer, you may have to pay excise tax depending on whether or not you engage in the following ac­tiv­i­ties:

• Selling or man­u­fac­tur­ing products that incur excise tax
• Operating certain kinds of business that are con­sid­ered luxury services, i.e. tanning salons
• Using certain types of equipment, fa­cil­i­ties, or products
• Receiving payment for certain types of ac­tiv­i­ties

There are further taxes to be paid if you are involved in the sale of certain chemicals, fuel taxes, heavy vehicle tax, and com­mu­ni­ca­tions and air transport tax. Excise taxes are filed using form 720, Quarterly Federal Excise Tax Return.

In­for­ma­tion returns

As a business owner, sole pro­pri­etor, or free­lancer, it is your re­spon­si­bil­i­ty to submit sup­port­ing documents for all your tax filings to the Internal Revenue System (IRS). They will then compare the documents you have supplied to the in­for­ma­tion on your tax returns to ensure that any and all payment trans­ac­tions are properly accounted for. There are a number of forms you are also required to include in your sub­mis­sion:

Form 1099-MISC, Mis­cel­la­neous Income reports on the following incomes:

• Payments of $600 or above to people not con­sid­ered employees
• Rental payments of $600 or more
• Prizes or awards of $600 or more
• Royalty payments of $10 or more
• Sales greater than $5,000 to people intending to resell outside of a permanent retail es­tab­lish­ment.

form W-2, Wage and Tax Statement will need to be filed if you have employees to record in­for­ma­tion, such as their wages, tips, with-held income, social security, and Medicare taxes. Every employer engaged in a trade or business who pays re­mu­ner­a­tion, including noncash payments of $600 or more for the year must file a form W-2 for each employee.

Form 8300, Report of Cash Payments over 10,000 Received in a Trade or Business needs to be filed if you are party to a cash trans­ac­tions greater than $10,000 in either the US or a foreign currency.

Reducing taxable profit and saving on your taxes is important for free­lancers and sole pro­pri­etors to maintain financial strength. Overall, the self-employed enjoy a rel­a­tive­ly wide margin of taxation, and have the pos­si­bil­i­ty to deduct a number of expenses from taxation, which above all con­tributes to them saving on their taxes.

Since operating expenses are not specif­i­cal­ly defined in income tax leg­is­la­tion, it is possible to claim many ex­pen­di­tures as tax de­ductible operating expenses. Typical examples of this would be, for example, travel expenses, ad­ver­tis­ing costs, catering, work equipment, or company cars. To claim this ex­pen­di­ture in your tax returns, it is of the utmost im­por­tance to be able to provide cor­re­spond­ing documents for all expenses in your in­for­ma­tion returns. This is best practice for all business ac­count­ing.

Not all of the tax-related expenses mentioned above can be im­me­di­ate­ly con­sid­ered freelance tax de­duc­tions or self-employed tax de­duc­tions – some goods need a longer period to de­pre­ci­ate. De­pre­ci­a­tion is an income tax deduction which permits a taxpaying free­lancer or sole pro­pri­etor to regain some of the cost of certain property items – es­sen­tial­ly an allowance for the use and de­te­ri­o­ra­tion of property.

As mentioned pre­vi­ous­ly, de­pre­ci­a­tion plays a role in reducing tax for self-employed people. Property which can be con­sid­ered for de­pre­ci­a­tion includes: buildings, vehicles, machinery, furniture, or equipment used for the business. As well as physical items, patents, software, and copy­rights can also de­pre­ci­ate. Taxpayers must own or lease the property in order to avail of de­pre­ci­a­tion on them, and use them in the pro­duc­tion of income. Reporting de­pre­ci­a­tion is done using form 4562, De­pre­ci­a­tion and Amor­ti­za­tion.

Did you know that self-employed people have the option to create a savings program for their re­tire­ment, just like a 401(k)? These savings programs are known as In­di­vid­ual Re­tire­ment Plans and listed below are the most popular models from which you can choose:

• A sim­pli­fied employee pension can be created by filling out form 5305-SEP, Sim­pli­fied Employee Pension – In­di­vid­ual Re­tire­ment Accounts Con­tri­bu­tion Agreement. Many banks and financial in­sti­tu­tions have their own model SEP plans which are approved by the IRS too. With this option, you can pay as much as 25% of your net earnings into this account.

• 401(K) plans can also be taken out by the self-employed! These are known as a one-par­tic­i­pant or solo 401(k), which allow for con­tri­bu­tions of up to $18,000, plus 25% of your net earnings up to a total of $54,000 (2017 figures).

• Saving Incentive Match Plan for Employees (SIMPLE IRA Plan) where an employer can commit up to $12,500 of your net earnings (2017 figures). This plan can be created by filling out either form 5305-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers – for Use with a Des­ig­nat­ed Financial In­sti­tu­tion, or 5304-SIMPLE, Savings Incentive Match Plan for Employees of Small Employers – Not for Use with a Des­ig­nat­ed Financial In­sti­tu­tion.

The IRS website provides many resources for helping self-employed people find a suitable re­tire­ment plan for them­selves.

Catering costs can be a con­sid­er­able expense for both busi­ness­es and the self-employed. Business meetings and social gath­er­ings are important events to discuss new projects and maintain important customer re­la­tion­ships. This can also be extended to tickets to the theater, or a sports game. Un­for­tu­nate­ly, the IRS keep close tabs on this, so you will need to be able to un­doubt­ed­ly prove that the events you held/attended were for con­duct­ing business. If the IRS are satisfied with their findings, you may claim back up to 50% of the costs. As pre­vi­ous­ly mentioned, you will need to keep records and receipts for every purchase made and how it cor­re­lates to a business in­ter­ac­tion. As a self-employed person, you will need to file form 1040, Schedule C Profit and Loss from Business (Sole Pro­pri­etor­ship) or form 1040, Schedule C-EZ, Net Profit from Business (Sole Pro­pri­etor­ship).

In the same vein as en­ter­tain­ment expenses, you may be able to claim back some de­ductible tax on business related meals that you have paid for through­out the year. Business related meals are meals purchased when traveling for business, or meals purchased when en­ter­tain­ing a client for business. You may be eligible to claim back 50% of the cost of the meal if you retain your receipts, or 50% of the standard meal allowance should you not have receipts to hand. Meal expenses are filed for in the same forms as en­ter­tain­ment expenses.

Fur­nish­ing business partners or clients with gifts is all part of main­tain­ing a customer re­la­tion­ship, and as such, can be deducted from your taxes. Free­lancers and sole pro­pri­etors can claim up to $25 for gifts for each client per year. Sending a gift to the client’s company or family still counts, as it is assumed that the intended recipient will even­tu­al­ly receive the gift. Free­lancers and sole pro­pri­etors may not claim branded mer­chan­dise costing less than $4 that is widely dis­trib­uted among other clients.

A classic tax saving tip for a self-employed person concerns their company or business vehicle. In the USA, you can deduct the value of business miles traveled on your tax return forms by keeping all receipts and filing the actual expense incurred. You can also use the standard mileage rate afforded by the IRS which, in 2016, was 54c per mile. If you are adhering to the standard mileage rate method, you will need to keep a log of how many miles were work-related and how many were for personal use. The IRS will im­me­di­ate­ly be red-flagged if you claim that all driven miles in your personal car were work related.

Similarly, if you are using the actual expense method, you will need to keep receipts for all car payments, de­pre­ci­a­tion, reg­is­tra­tion, insurance, parking spot rentals, licenses, repairs, parking and toll fees in order to be able to claim them in your tax returns. You will then be awarded tax de­ductibles for the per­cent­age amount used for work.

Please consult the IRS website for more in­for­ma­tion about the business use of a car.

As a self-employed person, you are eligible to deduct taxes for any expenses incurred when fur­ther­ing your education, as long as you can provide that the ed­u­ca­tion­al pursuit was ben­e­fi­cial to your business by main­tain­ing or improving your job skills. You may deduct for tuition, books, supplies, lab fees, trans­porta­tion costs, as well as any other costs incurred during research. Naturally, this must all be ver­i­fi­able through sup­port­ing documents and receipts. Self-employed people may file for these tax de­duc­tions on form 1040, Schedule C Profit and Loss from Business (Sole Pro­pri­etor­ship) or form 1040, Schedule C-EZ, Net Profit from Business (Sole Pro­pri­etor­ship).

In the USA, you may receive a deduction for costs as­so­ci­at­ed with ad­ver­tis­ing and promoting your business if you are self-employed. Ad­ver­tis­ing is a broad category, and you will need to be able to prove that the services you are claiming are de­ductible for directly assisted with spreading the word about your company. Ad­ver­tis­ing through different media channels such as news­pa­pers, TV, magazines, as well as online ac­tiv­i­ties, such as social media ad­ver­tis­ing and direct e-mail marketing. You may also claim a de­ductible on costs for producing ad­ver­tis­ing materials, such as business cards, posters, brochures, and operating your website including site main­te­nance and hosting fees. It is also sometimes possible to claim for ad­ver­tis­ing related services, such as graphic designs and ad­ver­tis­ing content. The section for claiming ad­ver­tis­ing expenses is on form 1040, Schedule A. Click here for important legal dis­claimers.