4 Ways to Keep Your Taxes Down If You Are Self-Employed

Self-employment has its perks, but being your own boss can lead to headaches come tax season. In addition to the income tax, you’ll need to pay self-employment taxes that support the Social Security and Medicare programs.

But there are ways to reduce the amount you owe.

At the start of the new year, you may receive a 1099-NEC tax form or 1099-K tax form. You also may have received other income in the form of cash or checks for work performed in the previous year from being self-employed.

One of the best ways to lower your taxes paid on self-employed income is to increase your business expenses. As a self-employed taxpayer, you can write off expenses and take certain deductions against that income to help reduce your tax liability.

However, it is very important to hold on to all receipts for any business expenses related to purchases or professional services received and to keep accurate, up-to-date records of your business’s activity.  

Here are four easy ways to keep your taxes down if you are self-employed.

1. Driving expenses

If your self-employed income is from operating a ride-hailing or delivery business through platforms such as Uber or Lyft, you will be able to take a vehicle expense deduction. This allows you to recover some costs associated with wear and tear on your vehicle to operate your business.

Be sure to keep track of your business miles, personal miles and commuting miles as you will need to provide this information to take the deduction.

2. Home office expenses

Home office expenses is another deduction that you can take advantage of if you utilize part of your home as your office space to conduct business. A home office deduction can be calculated using the simplified deduction method, which is a prescribed rate of $5 per square foot of your home that is used for business up to 300 square feet.

Or you can use the actual expense deduction method, which allows you to write off a percentage of expenses related to rent, utilities, mortgage interest, property taxes and repairs and maintenance.

Other common deductible expenses related to your home office include website services, computer software, merchant fees, electronics and other supplies needed to run your business. 

You also can deduct communication expenses, such as a portion of your internet and cellphone bill, as long as those costs are directly related to your business. For example, if 20% of your time on the phone is spent on business, you could deduct 20% of your phone bill.

3. Depreciation deductions

If you purchase equipment, such as a laptop or a leaf blower for your business, you can categorize it as an asset and take a depreciation deduction — which allows you to spread the expense over the useful life of your asset.

For example, let’s say you purchased a new ergonomic office chair at the beginning of the year for $400. You will be able to classify this as an asset and take a $57.14 depreciation expense deduction each year over a useful life of seven years, which is standard for office furniture.

You can also take a Section 179 election to fully expense and deduct the asset in the current year — instead of depreciating it — to further reduce your tax liability. This is an annual income tax deduction taken by filling Form 4562 with your tax return.

4. S Corp election

Another way to keep your taxes down is by changing your business structure into an S Corp election with the IRS. You can make the S Corp election for your corporation or limited liability company.

For example, when operating your business as an S Corp, if your business income is $100,000 per year and you pay yourself a reasonable salary of $60,000, all income that exceeds your salary — $40,000 in this case — is not subject to self-employment taxes. Only the salary of $60,000 is subject to self-employment taxes. However, if operating your business as a sole proprietor, self-employment tax is due on the entire amount of $100,000 business income.

Financial Reviewer, RetireGuide.com

Ebony J. Howard is a certified public accountant and financial reviewer for RetireGuide.com. Her background is in accounting, personal finance and income tax planning and preparation. Ebony holds a dual degree bachelor’s and master’s in accounting from Clark Atlanta University. She is passionate about making an impact in the community, sharing her knowledge in financial literacy and empowering people to achieve greater financial freedom.

Source: kiplinger.com

Social Security Earnings Tests: 5 Things You Must Know

A big reason experts advise waiting until at least full retirement age to claim Social Security: You get to skip the Social Security benefits earnings test, which hits early claimers who are still working. But there are actually two earnings tests–an annual test and a monthly test–and the second one can help early retirees leaving work midyear avoid the trap.

Here are five things you need to know about the two Social Security earnings tests.

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Social Security Earnings Test for Annual Income

A woman smiles while working on her computer. A woman smiles while working on her computer.

The Social Security Administration always applies the annual earnings test first. Based on that test, the agency temporarily withholds $1 of a worker’s benefits for every $2 earned over $18,960 for 2021. In a year the worker hits full retirement age, the test is more generous–the worker forfeits $1 in benefits for every $3 in 2021 earnings above $50,520.

In the month a worker hits full retirement age, the annual earnings test goes away. The worker can earn whatever he or she likes, and the monthly benefit amount will be adjusted upward to take into account all benefits forfeited in the past (more on recouping lost benefits below).

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Social Security Monthly Earnings Test

Concept art showing a calendar. Concept art showing a calendar.

If you’re tripped up by the annual test, you still have a shot at your full benefit. The SSA will apply a monthly earnings test and set your payments according to whichever test is better for you. “It helps people who retire in the middle of the year not to be penalized,” says Jim Blair, a former Social Security district manager and a partner at Premier Social Security Consulting, in Sharonville, Ohio.

The monthly test can be used for only one year, usually the first year of retirement. And it comes into play generally for midyear retirees who have already earned more than the annual limit. Those who pass the monthly earnings test can receive 100% of their benefits for any whole month the agency considers them retired, regardless of total annual earnings.

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How the Social Security Monthly Earnings Test Works

Concept art showing a Social Security benefits application.Concept art showing a Social Security benefits application.

Here’s how the Social Security monthly earnings test works: If you’re under full retirement age for all of 2021, you’re considered retired in any month you earn $1,580 or less. If you reach full retirement age in 2021, you’re considered retired in any month you earn $4,210 or less.

Say a new Social Security beneficiary will turn 62, the earliest age at which you can claim Social Security but yet nowhere near his Social Security full retirement age, in June. He wants to retire at the end of June after making $100,000 in the first half of 2021, and he wants to start collecting Social Security benefits in July.

Based on the annual earnings test, he’d get no benefit. But in July through December, if he earns $1,580 or less each month, the monthly earnings test would open the door to full benefits. If he went over that amount in a month, then the SSA uses the $100,000 he earned through June and he would not receive a Social Security check for that month. 

When retiring in the year you reach full retirement age, the earnings test only applies in the months prior to the month of your birthday. The higher threshold of $4,210 would apply if the monthly test is used in 2021. The earnings tests count only earned income from a job or self-employment; investment income, for example, and retirement-plan payouts are ignored.

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Recouping Benefits Lost to the Social Security Earnings Tests

A person holding a Social Security check. A person holding a Social Security check.

The burning question when a person loses Social Security benefits to the earnings test: When do I get my money back?

Unfortunately, you won’t get all your temporarily forfeited benefits back in a lump sum at full retirement age. Instead, your monthly benefit amount is adjusted upward in the month you hit full retirement age to account for forfeited benefits. The disappearing benefits essentially reduce the amount of time you were considered to have claimed benefits early.

Say you took benefits at age 62 instead of waiting to your full retirement age of 66, giving your benefits a haircut of 25%. If you forfeited 12 months’ worth of benefits to the earnings test, at your full retirement age, you’ll be treated as if you claimed benefits three years early, instead of four. Your lifetime benefits reduction will get slashed from 25% to about 20%. That puts more money in your check every month, and if you live long enough, you’ll recoup all the benefits the earnings test temporarily took away.

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Beware of Receiving More in Benefits Than You Should

A woman who looks shocked with her hand over her mouth. A woman who looks shocked with her hand over her mouth.

If you work while claiming early benefits, call Social Security with your estimated earnings so you don’t get more benefits than you’re due. “Eventually, earnings are posted to your record and they’ll see they overpaid,” Blair says. The SSA will want the money back–and will withhold benefit checks until the overpayment is cleared.

Source: kiplinger.com

How Much Is Self-Employment Tax & How Do You Pay It?

Being self-employed is awesome. You enjoy more control over your work-life balance, choose your hours, and have more say in the people and clients you work with. But before you hand in your letter of resignation, you need to understand the challenges of being self-employed. More specifically, you need to consider self-employment tax.

Like most tax rules, self-employment tax may seem incomprehensible at first. But take the time to read up on the subject, and you just might find that getting a handle on this aspect of self-employment is easier than you think.

What Is Self-Employment Tax?

If you have a job, you’re familiar with the Social Security tax and Medicare taxes, commonly called FICA taxes, which your employer withholds from each paycheck. Self-employment taxes are the equivalent of Social Security and Medicare taxes for the self-employed. If you’re a freelancer, independent contractor, or small-business owner, you don’t have an employer to withhold these taxes for you, so you’re responsible for paying them on your own.

If you had self-employment income of $400 or more during the tax year, you’re required to calculate self-employment taxes and file Schedule SE attached to your individual tax return, Form 1040.

The Self-Employment Tax Rate

The self-employment tax rate is currently 15.3%. This rate includes two components: 2.9% for Medicare and 12.4% for Social Security.

There’s no limit to the amount of your net earnings from self-employment that’s subject to the Medicare portion of the self-employment tax, but there is a cap on the Social Security portion. This cap is called the Social Security wage base, and it changes every year. For the tax year 2020, the Social Security wage base is $137,700. For 2021, it rises to $142,800.

When you work for an employer, your employer withholds half of these amounts from your paycheck — 1.45% of your wages for Medicare and 6.2% for Social Security — and matches the other half on your behalf. As a self-employed taxpayer, you’re responsible for the full tax. However, you can deduct half of your self-employment tax as an adjustment to your gross income on Line 14 of Schedule 1.

In addition to the 2.9% Medicare tax, high earners pay an additional Medicare tax of 0.9% on income above the following thresholds:

Filing Status Threshold
Married filing jointly $250,000
Married filing separate $125,000
Single $200,000
Head of household $200,000
Qualifying widow(er) $200,000

How to Pay Self-Employment Tax

Now that you have an understanding of self-employment tax basics, you need to know how to pay the taxes you owe.

Like federal income taxes, self-employment taxes are a pay-as-you-go system. That’s why employers withhold federal and state income taxes and FICA taxes from each paycheck rather than having you write a big check to the IRS at the end of the year with your tax return. When you’re self-employed, you’re required to make quarterly estimated payments if you owe taxes of $1,000 or more.

IRS Form 1040-ES includes a worksheet on Page 6 for calculating your estimated self-employment tax, as well as your deduction for one-half of your self-employment taxes. You can use Form 1040-ES to calculate both your estimated self-employment tax and estimated income tax for the year, divide them by four, and pay them in four equal installments. Those installments are due on April 15, June 15, September 15, and January 15 of the following year. These due dates move to the following business day if the 15th falls on a weekend or holiday.

You can make your quarterly estimated payments online using IRS Direct Pay or by mailing a check with the vouchers included with Form 1040-ES.

When you file your tax return at the end of the year, you’ll reconcile the total amount of estimated tax payments you made with the amount of income and self-employment taxes you owe. If you paid too much, you can choose whether to have your overpayment refunded to you or applied to next year’s estimated payments. If you paid too little, you’ll have to pay the difference, and you might also be charged an underpayment penalty.

What Happens If You Don’t Pay Self-Employment Taxes on Time?

If you owe at least $1,000 in combined income and self-employment taxes for the year and don’t make quarterly estimated payments, the IRS will assess a penalty for underpayment of estimated tax when you file your tax return.

The IRS calculates the underpayment penalty by first calculating how much you should have paid for each of the four quarterly installments. Next, the difference between what you paid and what you should have paid is multiplied by the effective interest rate for the period. The effective interest rate is set quarterly. For the first quarter of 2021, that interest rate is 3%.

The penalty is calculated separately for each installment, so you may be charged a penalty for one quarter but not the others.

How to Reduce Your Self-Employment Taxes

Self-employed individuals have a lot of opportunities to reduce their tax bill through tax deductions. The more deductions you have, the lower your net income — and thus your self-employment tax — will be.

In order to qualify for a deduction, your business expenses must be both ordinary and necessary. Ordinary expenses are common and accepted in your trade or business; necessary expenses are helpful and appropriate for your business.

The kinds of expenses that are ordinary and necessary for your business depend on the type of business you’re in. Some common ones include:

  • Advertising
  • Auto expenses
  • Credit card merchant fees
  • Dues and membership fees
  • Home office expenses
  • Insurance
  • Interest
  • Legal and professional fees
  • Office expenses
  • Rent or lease payments
  • Repairs and maintenance
  • Subscriptions
  • Supplies
  • Taxes and licenses
  • Telephone and cellphone service
  • Travel
  • Utilities
  • Wages

For more details on common business expenses and what is and is not deductible on Schedule C, check out IRS Publication 535.

Before you go on a spending spree to avoid taxes, remember that you don’t get a dollar-for-dollar reduction in your taxes for every dollar you spend. Unless the expense is something you actually need for your business, it’s not a smart move to spend money simply to lower your tax bill.

For example, say you’re considering spending $1,000 on a new laptop. If you’re in the 24% tax bracket, spending $1,000 will save you about $240 in taxes. If you need a new laptop, spending the money may be a smart move. But if you’re spending $1,000 to avoid paying $240 in taxes, you’re better off keeping the $1,000 in your pocket.

Consider self-employment tax just another cost of doing business. Owing taxes means you’re making money. So while every smart business owner wants to do what they legally can to lower their tax bill, spending money unnecessarily isn’t the answer.

Final Word

If you’re still confused about self-employment tax, it’s time to get in touch with a professional, such as a CPA or Enrolled Agent. You can locate one in your area through H&R Block. If you’re new to the world of self-employment, a tax pro can answer any question you have, help you estimate your self-employment taxes, and give you smart ideas for lowering your tax bill.

So add those tax due dates on your calendar and come up with a plan to estimate and pay your self-employment taxes. It’s an important part of being your own boss.

Source: moneycrashers.com

How to Reassess Your Spending Plan in 7 Steps

Just like how your needs and preferences change, so do your spending and saving patterns. In turn, budgets are living, breathing things. With that in mind, the end of year is the perfect time to take a deeper look at your money situation and make changes to your spending plan. After all, how can you get to your destination without an up-to-date roadmap?

Here are steps to take to review your spending plan, and make tweaks accordingly:

1. Account for Changes in Living Expenses

If you’re feeling a bit of a squeeze with your budget, there are greater forces at large. It turns out the cost of living is increasing at the fastest rate in a decade.

It’s easy to turn a blind eye and take a “blame the man” stance about your money situation. But it’s super important to take a look at what’s shifted with your personal expenses and make changes within your sphere of control.

For me personally, this has been what I’ve called my year of forced upgrades. I had to buy a new cell phone and eventually switch carriers, was forced to relocate out of my apartment, and bought a new car to retire my 15-year clunker. As you might imagine, this resulted in increased expenses. This affected my renters and auto insurance policies, not to mention tacked on one-time a bunch of one-off expenses.

Check and see what expenses have changed in the past year, and account for anticipated changes in the upcoming year. For instance, maybe you are planning to move cities, have a baby, or travel more.

2. Look for Spending Patterns

While changes in your bills is one thing, looking for trends in your everyday spending can be a more challenging task. Review your transactions in the past year using a money management app or by scouring debit or credit card statements. Break it down by category, or by retailer. I recently checked and found that I my bougie side has emerged this year, and I’ve been spending more on higher-quality, pricier foods. On the flip side, I haven’t been eating out as much.

Looking at your spending patterns will help you gauge how much you should set aside for discretionary (aka variable, or non-bills) spending. Check to see how much you spend on groceries, shopping, entertainment, eating out in a given week or month, then allocate accordingly.

3. Plan the Months Ahead

Ideally, you should have a spending plan in place for the next six to 12 months. That way you can set up goals for big-ticket items such as to create saving goals for major expenses, such as trips, birthday parties, and equipment for my hobbies and projects.

“Keeping an up-to-date spending plan is useful and beneficial because it allows you to plan how you want to use your money, instead of looking back and wishing you had done something differently,” says Kayse Kress, a CFP® and fee-only financial planner for physicians. “It’s important to prioritize your goals in case you can’t accomplish everything right away. Don’t feel discouraged and think of it as something you can work towards down the road.”

4. Cut Back By Using the “Cost-Neutral” Approach

One way you can approach slashing expenses so to go for the “cost neutral” approach. What this essentially means is that try to cut back in some areas, and put the money saved into other expenses. Doing so will “null” another expense.

When I switched cell phone carriers, I expected to pay more. But I ended up saving $50 a month on my cell phone bill by switching from a personal account to a small business one (self-employment perks). That $50 is going toward a recurring expense for my freelancing business.

My good friend Greg is a master at referral codes. He’s probably doled out enough referral codes for ride-sharing apps and food delivery services to save him $1,000 in eating out and transportation (no joke).

5. Save by Going for the Easy Wins

To give yourself a motivational boost—or if you don’t have a ton of time—go for the “easy wins” first. This means seeing if you can lower or nix any of your recurring expenses, such as your cable bill, insurance policies or subscriptions.

All it takes is a call to the company to see what discounts or promos are available. For instance, many insurance policies offer a discount rate if you opt for a bundle, sign up for autopay, or with group discounts. For instance, I scoured my internet bill to discover there was a $10 monthly charge to use the service provider’s router. Most of the time you can return their router and use your own.

If you’re nervous about putting on your negotiator hat, ask a trusted friend or family member to haggle on your behalf. (Yes, I’m usually that friend who loves to ask for a better deal.) Or use a service such as Trim or Truebill.

6. Pay Yourself First

While this may not always be realistic, aim to save for your saving goals, then live off the rest. You’ll need to figure out how much you need for living expenses, and lower expenses as necessary. But it feels great to be able to pay steady progress on the things you care about the most, and not have all your money be spent nilly-willy, only to feel frustrated that you haven’t made a dent on your goals.

7. Set Up Money Dates With Yourself

Checking in once a year is great, but ideally try to check in monthly to account for any changes. If you’re partnered and share expenses, make a point to touch base and chat openly about money on the regular. I love my money dates, and do it once a week to categorize expenses, come up with money flows, and look for areas I can cut back.

It’s all about having a plan, so you can feel more in control of what you do with your money, explore different options, and create your own approach and style to how you manage your funds. Not only will it prevent you from experiencing financial stress, but you can better align your spending with your values and your goals. And that’s what a spending plan is all about.

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Source: mint.intuit.com