As a self-employed individual, you may face more challenges in paying your income taxes than workers in typical 9-to-5 jobs. The largest difference, perhaps, is that you are required to pay quarterly taxes in April, June, September and January, instead of simply preparing your taxes ahead of April 15th each year. This year, before you begin preparing your quarterly taxes, first consider some of these potential pitfalls so you can remain in compliance with Uncle Sam.
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What is considered a home office?
One of the largest deductions you can make against your self-employed income involves your home office. Assuming you haven’t rented a separate space dedicated to your business, you’ll need to be very careful in formally establishing your home office. According to the IRS, in most cases that space must solely be used for your business activities and a majority of your business activities must be conducted within.
Once you’ve properly established a space for your home office, you must decide whether to take the simplified deduction, calculating $5 per square foot of office space deducted against your earned income, or to itemize your home office expense. This is calculated as a percentage of your entire home and applied to rent or mortgage payments, utilities and other expenses shared with your home office. When you file your quarterly taxes, remember to only deduct expenses from that quarter.
Set aside adequate funds
When you are an employee, the amount you receive from your paycheck already has taxes deducted. When you are self-employed, however, you’re receiving direct payments from clients and taxes have not been deducted. That’s why it’s critical to set aside adequate funds every single time you receive a client payment, so you aren’t scrambling to come up with money to pay your quarterly taxes.
A good rule of thumb is to set aside one-third of your earnings toward quarterly tax payments. Once you calculate your quarterly taxes, you may find that your tax bracket is a lot less than one-third of your income. However, it’s always a good idea to set aside extra funds instead of too little.
A great way to set aside adequate funds for your quarterly taxes is to treat it like any other household bill to pay. Set yourself a due date every month and put aside those funds then. You may even be able to automate the process by automatically transferring funds from your checking account to your savings account.
As a self-employed individual, the most important thing you can do for the success of both your business and your tax payments is to document every single thing. If you are spreadsheet savvy, you can design your own form to document your income, time worked on each project and outstanding payments. You should also document expenses incurred outside of your home office such as mileage, travel and professional association or training expenses.
Not a fan of spreadsheets? There are many products on the market that are designed to track everything related to your business. These software packages make it easy to compare products and choose the best one for your circumstances.
Staying in compliance with the IRS
Filing your taxes can be tricky as an individual and is even more so when you are self-employed. Instead of finding yourself in a situation where you owe more to the IRS than you can afford to pay, it may be in your best interest to consult a tax attorney. Doing so can ensure that you remain in compliance with the IRS and aren’t caught short of necessary funds to pay your quarterly tax bill.