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Tax Tips for the Self Employed
from: R.L. Fielding
Tax Tips for the Self-Employed
By R.L. Fielding
If you are self-employed, it's important that you take control of your finances and become aware of the changes that can affect your taxes. But how do you know if you are considered by the IRS to be self-employed? And if you are, what should you know? The following is a comprehensive list of answers to these questions and others regarding things that all independent contractors, small business owners, and other self-employed people ought to know:
First, find out if you are considered to be self-employed. Generally, you are self-employed if you:
* Operate as an independent contractor
* Are the sole proprietor of a business or you practice a trade
* In some way or another are in business for yourself
If you meet these criteria, there are a number of important things to know about your taxes, including:
* Up to 100 percent of medical insurance costs paid by self-employed individuals, covering themselves, their spouse, and their dependents, may be deducted as an adjustment to income on Form 1040, U.S. Individual Income Tax Return. The deduction is subtracted directly from total income and applies whether or not a taxpayer itemizes.
* If you use your vehicle for business purposes, you may be able to deduct expenses associated with such use. To do this, you must keep track of the business miles and total miles you drive during the year. You may choose the actual expense method or use the standard mileage rate. If you choose the actual expense method, you must also keep track of your vehicle-related expenses for the year. Vehicle related expenses include gas, oil, insurance, repairs, cleaning, registration, etc. The business portion of your personal property taxes and vehicle loan interest is also deductible.
* You may be entitled to a tax break if you are operating a business from your home.
o Is this part of your home used regularly and exclusively in conjunction with your business or work?
o Is it your principal place of business?
o Is it where customers and clients meet with you?
o Is it where you store product samples?
o Is it where you administer or manage your trade or business?
If so, you may be able to deduct certain depreciation and operating expenses. The same might apply to a separate structure.
* You may recover your investment in certain business-related properties (such as equipment, a vehicle, or a building) through the use of depreciation. Through depreciation, you will deduct some of your cost on each year's income tax return. If you do not take the depreciation, you lose it and when you sell the property, the IRS calculates the basis as though you had taken the deduction each year. If you have not claimed or have under-claimed depreciation deductions on property placed in service in prior years, you may be able to fully recover all allowable depreciation by filing amended returns for the years in question or by changing your accounting method.
* Up to $102,000 (for tax-year 2004) of certain tangible business property may be deducted in the year it was placed in service rather than using the depreciation method (section 179 expensing). The maximum amount that may be deducted for qualifying enterprise zone, renewal community, and Liberty Zone property is $135,000 (for tax-year 2004).
* Your employees' wages and salaries are deductible if paid during the tax year for work directly related to your business and if the pay is reasonable, considering the nature of the work. You must be able to verify that the payments were made for duties actually performed. There are various types of withholding for different types of employees. Specific forms must be used for reporting payments made to employees.
* You may be able to deduct expenses for a leased asset such as a car or computer used in your business. If it is not used solely for business purposes, you may deduct only the percentage of use that applies to your business or work.
* Business tax credits can reduce your tax liability. There is a credit for providing access to the disabled and a work opportunity credit for providing work for members of groups with special employment needs or higher unemployment rates.
* Freelancers who qualify to use Schedule C, Profit or Loss from Business, can report their deductible business expenses on that form. If these deductions were taken on Schedule A, Itemized Deductions, they would be subject to the 2% of adjusted gross income limitation.
* Costs that you have in setting up an active trade or business, or investigating the possibility of creating or acquiring a business, are business start-up costs. These costs are amortized rather than depreciated. Franchise fees, goodwill, and customer-based intangibles are also amortizable.
* If you are an accrual-basis taxpayer and you have been unable to collect money owed to you or your trade or business, you may be able to deduct it on your income tax return. You must have previously included the money owed as income so that you have a tax basis in the debt. A cash-basis taxpayer normally does not report income until they receive payment so they cannot deduct a bad debt.
* The tax implications of a self-employed individual are different from those of an ordinary wage earner. Each situation may present a number of complex tax questions. Here are some of the things you need to take into consideration:
o How much Social Security and Medicare taxes, FUTA taxes, and workers' compensation insurance will you pay?
o Will you have more than one trade or business?
o What if your attempt to operate a business fails?
o Should your financial calculations be based on a calendar year or a fiscal year?
* Starting January 1, 2004, certain individuals who are covered by a high deductible health insurance plan may be able to contribute to a health savings account (HSA). With this account, contributions are deducted from your gross income when calculating adjusted gross income, which means you do not need to itemize deductions to take advantage of this deduction. Additionally, distributions are not taxable if used for qualified medical expenses. The first time a HSA can impact your income tax return is in tax-year 2004
Because there are so many factors to consider when filing as someone who is self-employed, it may make sense to have a professional file your taxes for you. There are many benefits to doing so, including:
* A tax preparer can offer income tax help (http://www.jacksonhewitt.com/tackle.asp) and ensure that you get the maximum refund to which you are entitled as quickly as possible with a paper return or electronic filing.
* You have the option of electronic tax filing (http://www.jacksonhewitt.com/resources_library_topics_efile.asp). To use electronic filing, you must have a valid Social Security number for every person included on the return. IRS e-file® uses automation to replace most of the manual steps needed to process paper returns. As a result, the processing of electronic tax filing returns is faster and more accurate than processing paper returns. Jackson Hewitt has taken electronic filing to a new level. We've developed a process that provides income tax help that reduces errors even further and manages the entire electronic filing process to get your refund to you as quickly as possible.
* Professional tax preparers use industry state of the art income tax preparation software, which contain built-in error-checking and diagnostics.
Whether you choose to do your taxes yourself, or have a professional prepare them for you, if you are self-employed it is imperative that you be aware of the issues surrounding your taxes. It's not enough to avoid an audit - you want to save money, too!
For more tax tips and information on tax preparation, please visit the Tax Resource Center on the Jackson Hewitt website, at http://www.jacksonhewitt.com/resources.asp.
This article is copyrighted by Jackson Hewitt. It may not be reproduced in whole or in part and may not be posted on other websites, without the express written permission of the author who may be contacted via email at jh@digitalbrandexpressions.com.
About the Author
R.L. Fielding has been a freelance writer for 10 years, offering her expertise and skills to a variety of major organizations in the education, pharmaceuticals and healthcare, financial services, and manufacturing industries. She lives in New Jersey with her dog and two cats and enjoys rock climbing and ornamental gardening.
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