- Determine if you need to pay taxes.
- Decide who will do them – you or a tax professional.
- Collect your paperwork.
- File your taxes or send them to a professional.
- Plan for next year’s self-employment taxes.
Determine if You Need to Pay Taxes
For most people, it’ll be pretty obvious if you need to pay taxes: If you’re self-employed and earning a living, the IRS is going to want some of that.
On the other hand, if you’re just starting your business and have barely earned a cent, maybe not. According to eFile.com, “You must file a tax return if your total self-employment income is at least $400.” It adds, in case there is any confusion, “This is different compared to if you are an employee and these payments are automatically withheld from your pay and paid for you by your employer.”
But generally, if you are working for yourself and earned a living in 2020, you will need to file a tax return in 2021.
This is a decision anyone doing their taxes needs to make every year. Still, if you’re recently self-employed and have always done your own taxes, keep in mind that there are good arguments for hiring a professional rather than doing this on your own. After all, when you’re an employee, your taxes are taken out for you, and you may not have a complex financial situation.
As for how much it will cost to hire a tax professional, it varies. According to the National Society of Accountants’ most recent report, the 2018-2019 Income and Fees Survey, most people will pay roughly $188 for a tax professional to prepare a Form 1040 and state return with no itemized deductions. If there are deductions, on average, you’ll pay $294. Given that a self-employed person’s taxes will often be more complex than average, your cost may be slightly higher.
Collect Your Paperwork
Lisa Greene-Lewis, a certified public accountant, TurboTax spokesperson and contributor to the U.S. News My Money blog, says, “Before you start filing, be sure to gather and report all sources of income, including all 1099 forms. If you are self-employed, whether working as a freelancer or working a side gig, you will need to look out for the new Form 1099-NEC starting the end of January that will be issued if you were paid $600 or more.”
The new form is important to note, if you’re used to filling out Form 1099-MISC.
“The Form 1099-NEC replaces the Form 1099-MISC that previously reported self-employment income,” Greene-Lewis says. “Form 1099-MISC is still around but will not be used to report self-employment income. You also may receive a 1099-K form if you accept payment through a third-party provider, have more than 200 transactions and make more than $20,000.”
Greene-Lewis says that even if you don’t receive 1099s, “it’s important to keep careful records and track all income under these limits as you still need to report all income regardless of whether or not you received the forms.”
There may be a lot to collect, depending on your job. You may have expenses, such as computer equipment or printer ink. You might drive a lot and need to track your mileage. You will probably be able to deduct a decent amount of medical expenses.
“And don’t forget about the home office deduction, which is one of the biggest deductions for the self-employed since it is a portion of your expenses like your rent, mortgage interest, property taxes and utilities based on the percentage of space you use for you home office,” Greene-Lewis says.
Joshua Zimmelman, president of Westwood Tax & Consulting LLC in Rockville Centre, New York, says, “Employees have limits to what expenses they can deduct, but if you’re an independent contractor or freelancer, you can deduct many business expenses. For a Lyft or Uber driver, for example, this might include gas, parking fees, car maintenance and repairs, auto insurance and any other expenses you incur for your car.”
On the other hand, if you have a business where you’re at your computer a lot, rarely purchase equipment and never leave your home office, you may not have much to deduct.
And Zimmelman adds that the limits employees have to what they can deduct may be even more impactful this year. If you’re an employee who was directed by an employer to spend most of 2020 working from home due to the pandemic, and you are hoping for a bunch of deductions or tax breaks, you are unfortunately out of luck.
“Employees cannot deduct any expenses associated with employment,” Zimmelman says. “Despite many people working from home in 2020, that new desk chair or curved flat screen monitor cannot be written off if you’re an employee. We’ve gotten many questions about this, followed by disappointment when I share the regulations.”
File Your Taxes or Send Them to a Professional
This is a pretty self-explanatory step in the process. Just be sure, if you’re doing your taxes, to give yourself plenty of time to do them. If you have a few days, or even weeks, until the April 15, 2021, deadline, and you can spend time preparing your taxes without looking at the clock, you’ll be less inclined to make errors.
Plan for Next Year’s Self-Employment Taxes
This is where you’ll really do yourself a favor for next year. Start preparing for your 2021 self-employment taxes now.
“Each year, a few new clients come to me with issues from self-employment. The most common is failure to pay estimated taxes,” says Beth Logan, an enrolled agent and owner of Kozlog Tax Advisors in Chelmsford, Massachusetts.
Logan adds: “Self-employed people must pay their federal income tax, their state income tax – if any – and their Social Security and Medicare contributions. Self-employed people are both the employer and the employee. Therefore, they pay both halves of the Social Security and Medicare contributions (called self-employed tax or SE tax), which totals 15.3% of profits up to the Social Security income limit.”
That adds up. “When you include SE tax, federal income tax and state income tax, the amount owed can easily be 25% to 40%, even for middle-income Americans,” Logan says.
If you aren’t ready for that, Logan says, it can be pretty shocking to find out what you owe the IRS.
She says estimated taxes should be paid quarterly – April 15, June 15, Sept. 15 and Jan. 15 – based on your profits for that quarter.
So if you are self-employed and feel like you weren’t ready to prepare your taxes this year, start working on next year’s now, while you’re in the proper financial mindset. Your future self will thank you.