6 tips for organizing taxes if you're self-employed
Start by estimating what you'll owe in federal and state taxes and setting that money aside. Then look at potential deductions.
This post is by Steve Rosenbush of The Wall Street Journal.
One of the pains of being self-employed is handling your own taxes, which means regularly setting aside the money you think you'll owe to the IRS and your state. But how do you figure out how much that will be?
It's the kind of thing salaried employees take for granted. But freelance workers and other sole proprietors have to be their own payroll department.
Here are some tips to help the self-employed meet their tax obligations:
Get state and federal info
The first step is to download some 1040 ES forms from the Internal Revenue Service. The forms are used four times a year, when estimated federal taxes are owed, two weeks after the close of each quarter, on April 15, June 15 and so on.
You might as well download IRS publication 583 as well: suggestions on starting a business and keeping records.
If your state collects income tax, it likely requires quarterly filings as well. Go to your state tax authority's website for any required forms.
Different states may also require annual filings in addition to income tax, like a franchise tax. Again, check your state tax department's website.
Estimate your income
It's not always easy to know in March, say, how much you're going to make for the year. Depending on the business, income can arrive in varying amounts and on varying schedules.
"There's no way to predict your freelance income down to the penny, unless it is totally stable," says John Hewitt, founder of Liberty Tax Service and co-founder of Jackson Hewitt Tax Service. "But most people can make an estimate that is somewhere in the ballpark."
If all else fails, use last year's income as a baseline, and do your best to calculate what you expect the percentage change to be, for better or worse.
If you can't calculate your income with precision, at least try to estimate your income-tax bracket.
Calculate how much income to set aside
Hewitt recommends setting aside at least 30% of your income. "Federal, state and self-employment taxes tend to add up to 30% to 40% of income," he says.
Estimate your deductions
A lot of business expenses are deductible: meals and entertainment, gifts, furniture, phones and other tech.
Keep careful track of home-office expenses, advises Sara Horowitz, the founder of the Freelancers Union, a New York City-based organization that provides group rate insurance and other services to the self-employed.
Separate credit cards, checking accounts, phones and computers help, too, says Jackie Pearlman, a principal tax adviser at H&R Block. "The key to this is good record-keeping."
At the start of each year, add up all of the deductible expenses you know you will have and subtract that from what you estimate your annual income will be. Then divide by four to get your quarterly income estimates.
Depending on the type of equipment and how expensive, you may choose to spread the deduction over the period of the equipment's "useful life" -- three to seven years depending on what the equipment is.
Good tax planning involves looking at various options over several years to see what works best for your business, Pearlman says.
Should you make estimated payments?
Determine whether you need to make estimated payments. Here's where the 1040 ES forms come in. If you think you will owe the IRS more than $1,000 for the year after withholding and refundable credits, then you will need to make four estimated payments.
By law, the payments must be equal in size, according to Horowitz, author of the "The Freelancer's Bible."
Check your state to see what the threshold is for filing estimated payments.
Create a special account
Don't delay the inevitable. Create a separate account for the money you will be using to pay your taxes throughout the year. Choose a percentage of your revenue to set aside, and steadily make deposits in the account whenever money arrives.
The goal is to segregate the tax money in a bank account or other relatively safe instrument so that you don't spend it or lose it in a risky investment.
A corporate treasury department would do the same thing.
More from The Wall Street Journal and MSN Money:
- What to look for in a tax preparer
- Should you claim a home office deduction?
- How to file taxes for free, or nearly free, online
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