W2 employees have it so easy when it comes to tax season. They can comfortably expect to get paid on a consistent schedule, with the taxes conveniently withheld so they don’t even have to think twice about it. Then, they enough resource available to them in order to get their taxes filed by the time April 15 rolls around.
Unfortunatly, it’s not so simple for us self-employed folks.
When you’re on your own, it’s your responsibility to do the math and withhold the taxes out of each check as well as keep track of every expense. That can be a headache for someone who’s never had to worry about details like this, so here are 5 essential tax tips every self-employed person should know:
Take 30% out of every check you get
Sorry, there’s no way around this one. This is an easy way to make sure you are setting aside enough moola to cover your costs. 30% may sound hefty but when you factor in Federal tax (everyone), state tax (most folks) and self-employment tax (all non-C corp entrepreneurs), then 30% is a good safety net. Depending on if you live in a high tax state such as CA or NY, you may consider setting aside upwards of 40%. Yes, It sounds extreme but better to not stress about paying your taxes when the bill comes.
The Self Employment Tax
The self-employment tax is made of 2 parts: 12.4% social security and 2.9% Medicare, for a total of 15.3%. When you work as a W2 Employee, you and your employer comfortably split the 15.3% social security tax. Since you’re self-employed, you are responsible for the entire bill because you are considered both the employer and employee. I know, it sucks. But it costs to be the boss!
The Home Office Deduction
If the space that you use as an office takes up 20% of your house, then you can deduct 20% of your home bills like rent, utilities, mortgage interest, property tax, and homeowners insurance among others. So keep track of your bills because this is a potentially huge savings opportunity.
Deduct Health Insurance Premiums
If you buy your own health insurance, then you can deduct your premium as a self-employed person.
The deduction allows you to reduce your adjusted gross income by the amount you pay your premium. You’ll find the deduction on your personal income tax form, and you can claim the deduction if you were self-employed and showed a profit for the year.
Choose Your Own Retirement Plan
Retirement can be intimidating, but you have so many options when you are working on your own since employees are typically limited by their employer options. You can contribute pre-tax money to a simplified employee pension (SEP) IRA or a solo 401(k), both of which have higher annual limits than traditional or Roth individual retirement accounts.
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My tip for you: don’t stress. Transitioning into self-employment is a huge change but as you already know, the independence is truly worth it. To make things less overwhelming, you can pay your taxes in estimated quarterly payments so that you are in compliance with the IRS and your state taxing authority.
For more information, consult the IRS Self Employed Tax Center to start an in-depth look into your options.
With love,
Chika
