With April 15th fast approaching, and a couple things lining the calendar for the next couple weekends, I thought I would bite the bullet, fire up TurboTax, and finalize my 2008 taxes. Besides, the weather was dreary out and there wasn’t much else to do. I ran through estimates earlier in the year, and thanks to a bit of self employment income, had already ruled out the chance of receiving a tax refund. So I set things aside determined to revisit them in time to meet the tax filing deadline. I learned a few painful lessons.
Tax year 2008 was the first year I had any self employment income to speak of. It was also my first introduction to the self employment tax. When you work for an employer, you split the tax rate for social security and Medicare. But when you are in business for yourself you pay both sides of the equation – 15.3% (12.4% for social security and 2.9% for Medicare). It may not seem like much, but the self employment tax rate paid on top of your normal income tax rate can make for a large tax liability.
Estimated Tax Payments
Speaking of large tax liabilities, if you plan to have to pay more than $1,000 or so in self employment taxes, it is a good idea to make estimated tax payments on a quarterly basis to avoid underpayment penalties. Think of this as you withholding from your own income, similar to the way companies withhold tax payments from an employee’s paycheck.
Estimated tax payments may be made free online using the EFTPS (Electronic Federal Tax Payment System). Once your enroll at the site you are mailed a PIN to the address on record with the IRS. The pin takes a couple weeks to arrive, so plan accordingly. Once you have the PIN you may create an online profile/password at EFTPS and you are on your way.
To simplify things a bit, I set aside 30% of my self employment income (freelance writing, ad sales, etc.) in a sinking fund at one of our designated online banks. When the time comes to make quarterly estimates, I simply transfer money from my “Taxes” sinking fund using the EFTPS.
*Note, 30% may be too high or too low for your specific situation. It’s a good idea to review last year’s taxes and determine your tax liability for self employment income to come up with a starting amount due for this year. Be sure to increase or decrease that amount based on your revenues.
Improve Your Record-Keeping System
A good record-keeping system is vital to the success of any entrepreneurial venture. After all, without tracking profits and losses, how do you even know if what you are doing is worth the effort? It is also a big help around tax season. Even if all you do is create a file folder labeled “2009 Taxes” and toss all receipts and income statements there, it’s a start.
Those of us with self employment income have legitimate opportunities to deduct expenses from our income. For instance, as a blogger I can deduct things like hosting fees, domain registration and renewal costs, graphic design fees, etc. This is a short list of the many potential tax deductions for bloggers. Use only those that apply to you, and be sure to keep up with your receipts throughout the year to prove the expenses were paid.
Consider Hiring a Professional
Don’t take my word for it, consider consulting a tax professional, particularly when things get complicated. A CPA, or someone specializing in taxes for small businesses, will help guide you through filing the appropriate forms, help determine which expenses are deductible from your income, and help you avoid any potential audit red flags. I am a do-it-yourselfer by nature, but readily admit I will pay for tax advice when necessary. Considering the consequences of an audit, penalties, etc, it might be the most frugal thing you could do.