There are many benefits that come from being your own boss. If you work for yourself, as an independent contractor or operate a business as a sole proprietor, then you are self-employed. Self-employment can include a sideline gig, such as part-time work you do at home, in addition to your regular full-time job.
Filing taxes can get a little messy for self-employed individuals, particularly those who are artists, freelance writers, photographers or other creative professionals. Many self-employed filers wonder: What can I deduct? What does the IRS allow? Do I have to pay quarterly taxes?
Here are five things that the IRS wants you to know about self-employment and self- employment taxes:
1. You have to pay self-employment tax as well as income tax if you are self-employed. There is no way getting around it, generally. This applies even if you also have a full-time or part-time job and your employer withholds taxes from your wages. You will have to fork over a self-employment tax of 15.3% of your profit, which funds your social security and Medicare accounts. If you have a loss there is no self-employment tax. When you file your taxes as an independent contractor, you will report your income and expenses on an IRS Schedule C, Profit or Loss from Business, or C-EZ, Net Profit from Business form along with your Form 1040.
2. Your tax deductions are all “necessary costs” of running your business. These business expenses are costs that you do not have to capitalize or include in the cost of goods sold but can deduct in the current year. There are no set rules on what you can claim, the IRS allows you to deduct â€śall ordinary and necessary business expenses.â€ť An ordinary expense is one that is common and accepted in your field of business. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
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3. There are special rules regarding automobile, meals, travel, and entertainment expenses. When it comes to claims around these topics, itâ€™s all about intent. The IRS will allow all reasonable deductions if you can prove business rather than personal intent. Just make sure you keep receipts and other documentation to prove business use or intent.
4. You can deduct current expenses even on unfinished projects. The IRS has a special section 263(A)(h) designed to allow you to write off business expenses incurred thus far. For instance, you are writing a book but have yet to find a publisher or you have a painting that wonâ€™t get hung in a gallery for another year. You still get to deduct the materials used. This part of the tax code can only be applied to writers, photographers and artists who fall into the prescribed IRS definition.
5. There are some items that can possibly trigger an audit. Generally speaking, claims associated with meals, travel, and entertainment that appear more like fun than business. Say, you include deductions that are much higher than industry averages or not associated with your industryâ€”like traveling overseas. Other red flags are any discrepancies in reported income.