So, you finally started making money on the side, and then you hear about this crazy thing call self employment taxes! Ugh, a good way to ruin anyone’s celebration of success.
If you are new to making money from home, you are probably completely lost and stressed out just thinking about taxes. Here is the thing though, they really aren’t as bad as they seem.
Although I am going to focus on filing self employment taxes as a blogger, anyone making extra money from home can use these steps.
What are Self Employment Taxes?
First of all, it would help to understand what these taxes even are. Self employment taxes are essentially Social Security and Medicare taxes. As a normal, employed worker- you would still have to pay these. But, because the government doesn’t get its hand on your money before you do, it has to be paid after you have received the money. The catch is that since you are self employed, you have to pay the employee portion and the employer portion. This is because you are basically your own boss.
Social security taxes are 6.2% for the employer and employee each. So, being self employed means you pay 12.4% of your net income. Medicare is 1.45% resulting in 2.9% for those who are self employed.
It wouldn’t be so difficult to calculate if it were a matter of those percentages of your total income. But, it is based on your NET income. That is all the money you made for yourself minus any costs of doing business. This is where all those crazy deductions come into play that we will talk about later.
What Counts as Self Employment Income
Self employment is considered to be any money you make working for yourself. This could be cutting your neighbor’s lawn, babysitting, pet sitting, freelance writing, doing photo shoots, blogging, ghost writing and a ton more.
If your are considered an independent contractor for another business, you are also required to file self employment taxes. This is a little easier to know how much money you made because you will be issued a 1099 form to file with your taxes.
Accounting Methods for Self Employment
To determine what your income is for the year, you will need to keep uniform records of your earnings. To do this, you need to choose an accounting method that works for you.
The two main methods are called cash accounting and accrual accounting. Cash accounting is my personal favorite and what I use for my blogging business.
Cash accounting is a way of tracking your income (and expenses) based on the moment the money came into your possession or left it. This means that if you bought a computer on October 1st, you would account for it on that day. If you bought that same computer and used a credit card, you would count your payments towards that credit card when you made them and not the day you actually bought the computer.
Accrual accounting is a little more complex. If you did some freelance work for someone on December 30th and didn’t get paid for it until January 5th. You would count that as income earned on December 31st.
Once you choose an accounting method, you have to stick with it. If not, it make cause you tons of headaches during tax time.
Self Employment Tax Forms
If you are new to working from home and this is your first time doing your own taxes, you are going to have to add a form to your normal personal tax routine. This form is called a Schedule C or you can use a Schedule C-EZ. These forms, and all tax forms, are a pain in the butt to file manually. I would not recommend doing your taxes by hand if you have self employment income. But, I do believe that they are simple enough to complete on your own, instead of paying for an accountant. I use Turbo Tax Home and Business online to file my taxes and it has worked out great for me! It walks you through all of the different income and deduction sections.
Self Employment Tax Deductions
OK, let’s get to the good stuff. How can you avoid paying a crazy amount of taxes? This is my favorite part. It’s all about the deductions. Your business deductions lower your taxable income, which then lowers your tax bill.
The home office deduction is a great way to reduce you tax bill. You can claim this if you have a place in your home that is solely used for your business/blog. This could be a little nook or an entire room. The basic idea is that you figure out what percentage of your overall housing and utility costs come from that portion of the house. To do this, you will divide the square footage used for the business by the total square footage of the house. For me, my office/nook area is about 9 ft. by 10 ft. This makes my home office space about 90 square feet. Since my house is 1483 square feet, I can claim 6.07% of my total home expenses as a home office deduction.
If you don’t want to track each expense, you can take a standard deduction based on your office size.
Some of these expenses include:
- Electric/Gas Bill
- Water Bill
- Interior/Exterior Painting
- Property Taxes
- Mortgage Interest
- Mortgage Insurance Premium
- Homeowners/Renters Insurance
Retirement – SEP IRA
This is my favorite tax deduction, by far. If you set aside money for retirement in a qualifying account, you can deduct that amount from your net income. For 2015, the max contribution is 25% of your net business/self employment income up to $53,000. This means you can basically avoid paying taxes on up to $53,000 and let it grow tax free until it is time to retire!
Qualifying accounts include:
Since this is a finance blog, I’m going to recommend everyone max out their self employment retirement account.
If you use your vehicle to do anything related to your business, you can deduct these costs. The two methods of doing this are a standard deduction or tracking all of your vehicle expenses. I would almost always recommend taking the standard deduction. It is usually higher and a lot less of a headache. This deduction for 2015 is 57.5 cents per mile.
This can include:
- Driving to the store for supplies
- Going to a related conference or event
- Driving to a clients house or to meet for lunch
- Driving to the tax office to get your business license
Basically, any time you get in your vehicle for anything related to your business, track these miles!
The depreciation deduction for self employment covers anything you buy for your business that you expect to use for more that 1 year. The IRS takes a portion of the cost of the item as a deduction each year to potential span the life of the item. This means, instead of deducting the cost of your printer all in one year, it divides it up across a few years.
Rules to follow for depreciating an item:
- The item must be used in your business or to produce income.
- It must be expected to have a useful life of more than one year.
- That useful life must be limited: At some point, it wears out, breaks, is used up, or becomes obsolete.
Sample Depreciation Items:
- Laptop or Desktop Computer
- Fax Machine
Gaining more education is always something I support. Going to classes, conferences, and reading Ebooks are all examples of ways to grow in your self employment business and you can use these educational expenses as a tax deduction.
Pens, pencils, printer paper and ink can all be counted at office expenses. This one is pretty self explainatory.
Necessary/ Essential Expenses
For me, as a blogger, these kind of expenses are the things I have to have to run my blog. Some of these items include domain name registration, web hosting, blog themes, plugins for my website, and more. If it is something that is necessary for your business to function or grow, you can deduct it.
The trick to filing self employment taxes is to keep good records, don’t throw away a single receipt, and count every deduction you can. Self employment tax returns are the most common to get audited. This is why the records are so important. If you can prove you spent it and can rationalize why it is related to your business, the IRS cannot cause problems for you.