Money, Debt and Taxes

Tax time can be extra taxing for the self-employed. What really do you count as income? What can you deduct as expenses? And why do you have to pay self-employment tax? Here are a few tax tips to help you prepare your self-employed tax return.

1. What is Self-Employment Income?

Self employment income can be any income that you earn as an independent contractor, a freelancer, or even money that comes in from a hobby. You don’t need to make much to be considered self-employed by the IRS.

2. What Business Expenses Can You Deduct?

The good news is that you can deduct any expenses that you incur to create income. Many people have expenses for items that are used for both business and personal, such as computers and internet costs. In those cases the IRS allows you to take a prorated amount as a deduction. Keep a log showing how much is business use, and how much is personal use to come up with your prorated deduction amount.

3. What is Self-Employment Tax?

When you work for someone else as an employee you have social security taxes deducted from your paycheck. Your employer pays an additional amount. When you are self-employed you pay both parts yourself as self-employment tax.

4. How Do You Report Self-Employment Income?

If you are not a corporation or a partnership you will report your self employment income and expenses on Schedule C. It is filed at the end of the year with your Form 1040. However, taxes are due through out the year. Estimated taxes are paid with form 1040-ES.

5. Where Can I Find More Information on Taxes and Self-Employment?

The IRS has many great resources to help self-employed people with their taxes. Start with these links from the IRS.

• Publication 334, Tax Guide for Small Business
• Publication 535, Business Expenses
• Publication 505, Tax Withholding and Estimated Tax

Congratulations! You have your own business! Now the bad news. Uncle Sam wants a big portion of your income.
When you start your own business, one of the first things you must plan for is paying your taxes.

How Often Do You Pay Estimated Taxes?

As an employee, your employer takes taxes out of each and every paycheck. When you are your own boss, you need to pay the IRS, not just on April 15, but three other times during the year.
Estimated tax payments are due on:

1. April 15 for income earned from January through March
2. June 15 for income earned April through May
3. September 15 for income earned June through August
4. January 15 for income earned September through December of the previous year

Income Taxes, Self-Employment Taxes, Quarterly Taxes? Which is it?

The taxes you pay as a self-employed business owner go by many different names, one of which is quarterly estimated tax payments. I find this kind of funny, because as you can see from the list above, the taxes are not paid every three months, rather they are paid four times a year on a rather random schedule. I have yet to find out why this is.
When you are self employed, your estimated tax payments are actually for two different taxes, income taxes and social security taxes. Social security taxes are often called self-employment taxes when talking about self-employed individuals. This is because as an employee, you pay 1/2 your social security and medicare taxes and your employer pays the other 1/2. When you are your own boss, you get to pay the full amount! Lucky you.

So, to answer the question, the answer is all of the above. Your quarterly estimated taxes are made up of income taxes and social security taxes. They are paid four times a year, but are not equally space out.

How Much Should You Pay

Ideally, four times a year you would calculate your income for the previous time period, estimate your income and social security taxes, and pay that amount. A quick estimate of the amount you should pay would be your federal income tax rate, plus 15% for self-employment taxes, times your net income. For example, if you are in the 15% federal income tax bracket, your estimated tax payment will be about 30% of your net income. Net income is all the money that came in, minus the expenses that you paid to earn that money. As a very rough guide, I find that most of my clients do OK when they pay 15 to 20% of their gross income. Gross income, simply stated, is all the money that your earned. If you want to be more exact, you can use this IRS Estimated Tax Worksheet to calculate how much you should pay each year.

This video has some good information on easy ways to track and save for your estimated tax payments.

How Do I Pay My Estimated Taxes

There are two ways to pay your estimated tax payments. One way is to use paper coupons provided by the IRS, and mail your payments to the IRS. Be sure to write your social security number on your check. The IRS Estimated Tax Worksheet has payment coupons and the addresses for where to mail your payment.

The IRS would prefer it if you would use their Electronic Federal Tax Payment System. At this website, once you register, you can easily make your tax payments from your computer. You can even schedule your tax payments to happen automatically.

Can I Pay My Taxes More Often?

It might seem like a silly question, but you would be surprised by how many people would like to pay their taxes more often. By paying your estimated taxes monthly, or even weekly, the payment amount is smaller, and many people find it easier on their budgets if they pay their taxes more often than quarterly.
Yes it is OK to pay your taxe more often, just print additional tax payment coupons, or use EFPTS, the Electronic Federal Tax Payment System to make a payment whenever you want.

What If I Miss A Payment, or Can’t Make A Payment?

Don’t worry about it too much. If you miss a payment the IRS is not going to come looking for you. Just make the payment as soon as you can. You may be penalized for paying late, or for not paying enough, but if you pay as much as you can as soon as you can, the penalty will be minimized.
If the reason you can’t make a payment is that you don’t have any income, then you really don’t need to worry about it. (At least not the taxes. ) No income means that no taxes are due.

I’ve Paid My Estimated Taxes, Now What?

When it is time to file your tax return, your estimated taxes will work much like withholding taxes on your tax return. On the tax payments section of the tax return, there will be a place for you to record exactly how much you have paid in estimated taxes. If you paid too much, you will get a refund, if you didn’t pay enough, you will owe additional taxes, and maybe some penalties.

Get into the habit of paying your estimated taxes, and tax time should not be too much of a problem.
Do you have any questions about paying estimated taxes, or any other tax questions? Ask in the comment section and I will be happy to answer!

Once again the IRS has extended the First Time Home Buyer credit and now is a great time to buy a house!

What I find really exciting is now you don’t have to be a first time home buyer to get a modified version of the credit.

Here is the scoop. If you are a long time homeowner, defined as someone who has lived in their current home for at least 5 consecutive years, you can now qualify for the long time resident credit and get a tax credit of up to $6,500.

Here is how it works. For both the first time home buyer tax credit and the long time resident tax credit you must enter into a binding contract by April 30, 2010 and have closed escrow by June 30, 2010. Miss the deadlines by even a day, and you miss the credit.

You can claim the credit when you file your 2009 or 2010 tax return, or if you don’t want to wait, for homes purchased in 2009 you can amend your 2008 tax return.

The credit is 10% of the purchase price of the home, up to $8,000 for the first time homebuyers credit and $6,500 for the long term resident credit. The new home must be your principal residence for 3 years, or you have to pay back the entire credit.

There are some limits, the purchase price of the home must be less than $800,000 and a taxpayers modified adjusted gross income must be under certain limits. Just how much depends on when you purchase the home. For homes purchased before November 7, the credit starts to phase out at $75,000 MAGI, $150,000 for joint filers, and no credit is allowed for persons with Magi of over $95,000 or $170,000 for joint.
For homes purchased after November 6 the full credit is available for persons with MAGI of up to $125,000 ($225,000 for joint) and no credit is allowed for taxpayers with MAGI of over $145,000 ($245,000).
Find out all the details on the Home Buyers Tax Credits at the IRS site.

Now here is where I think it gets really interesting.

Make Tax Free Income From Your Personal Residence

Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money–That the Poor and the Middle Class Do Not!”
Robert Kiyosaki, of the Rich Dad, Poor Dad fame, said in his books that your home is not an asset. However, that was before the IRS made owning a home so attractive. Using a combination of the Home Buyers Tax Credits, Mortgage and Real Estate Tax Deductions, and the Tax Free capital gains from selling your home, it is possible to make large sums of tax free income from your home. Here is an example of how it might work.

You, as a first time homebuyer, buy a home for $80,000 on January 1, of 2010. You put 10% down ($8,000) and take out a 30 year fixed rate mortgage for $72,000 at 5%. Your monthly mortgage payments will be $386.51.

The first year, when you file your tax return, you get the $8,000 tax credit, in other words, the IRS just paid your down payment. You will have paid around $3,300 in interest, and maybe another $1,000 in taxes, giving you a tax savings of about $1,000. ( I am using round numbers here just to make it easy.) That is a total of $9,000 you didn’t need to earn, and $9,000 you don’t need to pay taxes on.

Years two and three are not very exciting, you still get the tax deductions and save around $1,000 per year.

After 3 years you decide to sell your home. Let’s assume the market has made a recovery (which is not an unreasonable assumption for 3 years out) and your home has increased in value 25%, to $105,000. Let’s play with the numbers.

First lets see how much cash it took to live in your home. (I don’t include insurance here, because even if you are renting your should be paying for insurance, and renter’s insurance and homeowner’s insurance cost about the same.)

Cash Out

If we add up the down payment ($8,000), the total monthly mortgage payments ($14,000) and the estimated property taxes ($2,400) we come to a total of $24,400 cash out of pocket to live in our home. But then we get to subtract the tax credit ($8,000) and tax savings ($3,000) to come up with a net out of pocket cost of $13,000. Not bad for three years of housing!

Now let’s see how the cash flows when you sell the home.

We sell the home for $105,000, but we have to pay the costs of selling the home ($8,400) and we have to pay off the mortgage ($68,000). That leaves us with cash in pocket of $28,600. Nice! Subtract from that the $13,000 cash out and you are left with $15,600 your don’t have to pay taxes on. Working a job and paying income taxes and social security taxes you would have to earn almost $20,000 to have the same amount of cash.

So by using the tax laws to your advantage you have lived in your house for free for 3 years and gained over $5,000 per year in cash flow.

In my book, that makes my home an asset!