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Self-employment income tax basics

Working for yourself comes with a lot of freedom but can also increase complexity when filing taxes. Lay a foundation for successful tax planning by finding answers to your self-employment tax questions. Then, work closely with your tax professional and an Ameriprise advisor to help ensure your tax strategy is on the right track.

Visit the IRS website for access to forms, instructions and other publications.
 

How does the IRS define self-employed?

Whether full-time or part-time, you are considered self-employed if any of the following situations apply to you:

  • You work as a freelancer, sole proprietor or independent contractor.
  • You own your own business (depending on what business structure you’ve created).
  • You are self-employed, a partner in a partnership, or a member of an LLC (limited liability company).

What is the self-employment tax?

  • Self-employment taxes are Social Security and Medicare taxes, similar to the Social Security and Medicare taxes withheld from an employee’s paycheck. 
  • As a self-employed individual, taxes are not withheld from your income.  It is your responsibility to make quarterly payments, as discussed below.

What are my self-employment tax filing obligations?

  • Generally, your tax obligations will include filing an annual tax return, in addition to paying estimated tax on a quarterly basis.
  • You are required to file an income tax return if your net-earnings from self-employment were $400 or more.
  • If your net-earnings are less than $400, you may still have to file a return if certain other filing requirements are met.
  • If you’re not sure how to accurately calculate self-employment tax or how much to save for self-employment tax, an Ameriprise advisor can partner with your tax professional to help you with tax planning strategies for your self-employment venture or small business.

What are quarterly tax payments?

As a self-employed individual or owner of a business, there are different kinds of taxes you must consider:

  • The self-employed generally do not have federal and state income taxes, Social Security and Medicare taxes withheld from their income. Therefore, it’s up to you to make those federal and state tax payments, which the IRS requires on a quarterly basis.
  • To avoid potential tax implications, underpayment penalties, additional interest, or back taxes when you file your annual tax return, you will need to pay your estimated taxes on a quarterly basis and by the IRS deadline.
  • Quarterly taxes are also known as estimated tax payments because they’re calculated based on your projected net earnings.
  • If your business has employees, you will have additional tax obligations beyond estimated quarterly tax payments. Refer to IRS Publication 15 to determine what those additional responsibilities may be and discuss them with a tax professional to determine the best course of action for your situation.

What are qualified business income deductions?

You may be able to deduct certain eligible business expenses, which may reduce taxable income. To be deductible, a business expense must fall into both of the categories below:

  • Necessary Business Expenses: A necessary business expense is one that is helpful and appropriate for your trade or business. Necessary business expenses include taxes, employee compensation and insurance.
  • Ordinary Business Expenses: An ordinary expense is one that is common and accepted in your trade or business. This can include uniforms, software or raw materials, depending on your line of business.

Track your expenses during the year and keep accurate records of each expense. Work with your tax advisor to determine which expenses may qualify as deductible.

Can I reduce my taxable income by contributing to a self-employed retirement plan?

Planning for retirement when you’re self-employed is an important part of maintaining your livelihood in the future. You may be able to save on taxes and reduce your tax liability when you contribute to these plans, first with a federal income tax deduction for enrolling in and funding a retirement plan and secondly by reducing your taxable income.

There are several self-employed retirement account options available to choose from depending on your financial needs and goals, including:

  • Solo 401(k), also known as the Self Employed 401(k)
  • SIMPLE 401(k) Plan
  • SIMPLE IRA (Individual Retirement Plan)
  • Simplified Employee Pension (SEP) Plan
  • Keogh Plan

Contributions to some of the above plans can help lower your taxable income as they are made with pretax dollars. That means you won’t have to pay taxes on any of your contributions until age 59 ½. If funds are withdrawn prior, you will have to pay federal income tax and a 10% premature distribution penalty tax.

Solo Roth 401(k)s are another option for a self-employed retirement plan, but contributions to these kinds of plans will not lower your taxable income, as they’re made with after-tax dollars. However, future distributions from this plan are not subject to tax withholding.

The right type of retirement plan for you will depend on your business type, future needs and overall financial goals.

Can I reduce my taxable income by contributing to a health care plan?

If you are not covered by an employer plan, you may qualify for a self-employed health insurance deduction, which allows you to potentially deduct up to 100% of health insurance premiums. The deduction applies not just to your premiums, but to premiums you pay for your spouse and dependents.

You can also deduct contributions to a health savings account (HSA), considered an “above-the-line” deduction. When you withdraw funds from an HSA to pay for a qualified medical expense, those withdrawals aren’t counted as income. However, non-qualified medical expense withdrawals are.

Get financial advice personalized for your business

An Ameriprise advisor can partner with your tax professional to help you create or update the tax strategy for your self-employment venture or small business.

Get financial advice personalized for your business.

Or, request an appointment online to speak with an advisor.

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Ameriprise Financial, Inc. and its affiliates do not offer tax or legal advice. Consumers should consult with their tax advisor or attorney regarding their specific situation.
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