- The types of business entities and how they are taxed
- What tax returns they must file
- When they must be filed
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How to Calculate Tax for Self-Employed Earnings in Las VegasSelf-employed individuals have two tax burdens to consider when calculating taxes on their self-employed earnings: income tax and self-employment tax. The self-employed are only subject to income tax, however, if their self-employment activities in a given year generate a net profit (if their business income exceeds their business expenses). This is because income tax is only calculated on net profit, not total self-employment earnings. For those self-employed individuals who are profitable, income tax operates in the same way for the self-employed as it does for the traditionally employed.Self-employed individuals must also calculate the self-employment tax on their earnings. This tax covers the entire portion of Social Security and Medicare taxes that all working Americans must pay. Traditionally employed individuals share this tax burden with their employers, but the self-employed must pay the entire amount; this equals 12.4 percent of your net self-employment earnings for Social Security tax and 2.9 percent for Medicare tax, or 15.3 percent in total. However, the employer-equivalent amount of the self-employment tax is deductible for the purposes of income tax.Related: The Tax Season Survival Guide: 9 Tips You Need to Know
3 Self-Employed Tax Mistakes That Could Cost You ThousandsBecause calculating tax for self-employed earnings is more complicated than doing so on employer-provided income, the newly self-employed face a lot of possible tax mistakes—and these mistakes have big repercussions. Three particular tax errors have the potential to cost you thousands.
Failing to Set Aside Money for TaxesMany self-employed individuals, particularly those that do freelance project work, find that their income fluctuates from year-to-year; the difficulty of estimating yearly income leads many to fail to set aside money for taxes. This can cause many potential issues if tax time comes and you don’t have the funds to cover your tax bill. Estimate your yearly income as closely as possible by looking at your previous year’s income and aim to save at least 30 percent of your projected income for taxes.
Incorrectly Reporting IncomeBoth under- and over-reporting your income can have tremendously expensive consequences for the self-employed. Overestimating your self-employment income will obviously lead to paying more tax than necessary, but underreporting your income may actually be costlier. Purposely or accidentally underreporting your self-employment income may constitute tax fraud, and underreporting your income can trigger an IRS audit and lead to massive civil fines, penalties and even prison time. If an IRS audits uncovers unreported self-employment income, tax penalties can begin at 25 percent for true mistakes and go up to 75 percent for purposeful fraud.Related: 5 Things to Do Right Now When Facing the Dreaded IRS Tax Audit
Missing or Not Documenting Any DeductionsFailing to take full advantage of all available tax deductions is potentially costly for all taxpayers, but the self-employed in particular stand to lose a lot of money by not taking all of the deductions available to them. With self-employment comes a long list of business expenses, and many deductions exist to directly offset a wide variety of expenses for the self-employed. If you run your business from your home, for example, you can potentially deduct all of your housing-related expenses generated by your business. Use of your personal automobile for business purposes can similarly be deducted.Related: How to Maximize Your Business Mileage DeducationOther potential deductions that all self-employed individuals should investigate include educational expenses, advertising and promotional costs, business-related entertainment and restaurant meals, and depreciation of business equipment. In all cases, strive to maintain accurate records including saving receipts throughout the year to make the process of figuring out your deductions easier at tax time.
How to File Tax Returns When You’re Self-EmployedIf you make at least $400 in income from self-employment, you must file an annual tax return using Form 1040. How you report your self-employment income to the IRS will depend on whether you are considered a self-employed business owner or a self-employed independent contractor. Business owners who submit a Form 1120 business tax return will report their income via Schedule K-1 while independent contractors submit their income information via either Form 1099-MISC or receipts. Both types of self-employed individuals will need to pay estimated taxes quarterly and any remaining tax owed with their tax return.Correctly calculating and filing your taxes when you are self-employed can be challenging, but proper preparation can help you avoid many tax pitfalls. Keeping accurate records throughout the year and seeking professional tax guidance when necessary can help save you money and keep you in good standing with the IRS.
The Leading Causes of Poor Record Keeping PracticesSome of the leading causes of bad record keeping practices include:
- Not taking bookkeeping seriously enough
- Managing all your accounting in-house
- Forgetting to track the smaller transactions
- Poor communication with your bookkeeper
- Organizational inefficiencies
3 of the Most Costly Bad Bookkeeping HabitsHere is a glimpse on 3 of the most common bad bookkeeping habits that can cause serious damage to the finances of your small business:1. Trusting an inexperienced (newbie) bookkeeperWe have mentioned that one of the leading causes of poor record keeping is doing all the accounting work in-house. It is always advisable to hire a professional bookkeeper who has the experience in handling all aspects of the practice for best results. Outsourcing your bookkeeping tasks can alleviate a ton of troubles. However, if you go for an inexperienced or newbie bookkeeper for a cheaper fee, expect costly bookkeeping troubles ahead.2. Keeping inaccurate books (falling behind on books)Keeping inaccurate books can cripple your business down to the very core. You can end up using more on your budget than the business is earning, filing less returns than you are supposed to, and generally losing track of your business profits.3. Missing tax deadlinesNo one ever wants the IRS knocking on their business door for an audit. But if your bookkeeping habits are in question—perhaps you are not paying the right amount of tax, you are missing on tax deadlines, or defaulting—you will surely get a visit from the IRS soon.
What Are the Consequences of Bad Bookkeeping?There are many tough consequences of bad bookkeeping. One is that you could lose an audit by the IRS auditors, causing your business to be levied hefty fines that can cripple your operations. Another consequence would be running into cashflow crunches because your business cannot operate effectively if the money flow is not flowing. You could also face losing your small company all together because of poor financial and business planning. Without proper bookkeeping, you simply can’t tell whether your business is growing, stagnant, or expected to close down.
How to Avoid Bad Small Business BookkeepingTo avoid poor bookkeeping, you need to have a system in place that ensures all your business records are well recorded from day one. Make sure that:
- All expenses are categorized properly
- Bank accounts are reconciled
- No sales tax is neglected
- Petty cash is well managed
- Reimbursable expenses are tracked
- Communication with the bookkeeper is good
Ways to Reduce Tax Liabilities for Your BusinessYou always have a chance to reduce your tax burden in legal and ethical ways and here are five strategies that might turn effective for your small business:
1. Create a Year-End Tax Planning StrategyYear-end tax planning is crucial when it comes to managing exactly what you are expected to owe and strategically reducing it. One way to do this is to make philanthropy a big part of what you’re doing. Firms that are giving back to their community can take big tax write-offs. A good rule of thumb is 10 percent. Devote 10 percent of your total income to charitable causes, and this will help eliminate a lot of extra taxation.
2. Know What You Can Write OffIn doing your taxes and working to reduce tax liabilities, track office expenses like environmentally sustainable equipment, furniture, travel, and conferences. Keep accurate records throughout the year to maximize their deductions in this area. Refer to the IRS website for a list of acceptable deductions.It also pays to know what the IRS is willing to give out tax breaks for. The United States Federal Government is known for giving all sorts of a write offs to businesses that focus on employing union workers, minorities, manufacturing, and exports. Emphasize exports to get some great tax breaks such as the IC-DISC.
3. Use Accountable PlansAccountable plans affect the tax liability of a small business. If you don’t have good records, do not count something as a deduction. The IRS might hit you hard if you didn’t honestly report your tax returns based on what you know. It is better to have fewer deductions but no IRS audit than to have many deductions and get an IRS audit. Go for simplicity and prioritize deducting major items.
4. Funding Employees’ Benefits Instead of RaisesA good way to save on taxes for your business is for you to compensate your employees by raising your contribution to their health insurance. Instead of increasing their salary, it’s a better option to give the same amount to cater for their medical expenses. For instance, if an employer increases the employee’s salary by $350 a month, those wages would then be subjected to Medicare taxation, FICA tax, and income tax.Consequently, the employer will share the cost of paying Medicare, FICA and may have to pay out for federal and state unemployment. Thus, instead of giving an employee $350 more, the company can pay the same amount to cover their medical insurance. Doing so will eliminate FICA, Medicare, income tax, and unemployment taxes, and both the employer and employee will be saved from taxation.
5. Hire an AccountantA trustworthy accountant can not only save you time and clear up the uncertainty of managing your finances and taxes but also has other benefits:
- Trusted advice: Besides preparing your taxes, an accountant can act as a reliable advisor to your small business, assisting you with cash flow management, assess risk, keep your books in order, and plan for growth.
- Help with managing your business and personal needs: Many are the times small businesses such as startups and sole proprietors finds their personal finances and business closely linked. To make sound judgment for the benefit of both, an accountant comes in handy.