The thought of being your own boss can be enticing, but being self-employed also comes with responsibilities – including tax implications that may be obvious and not-so obvious.
“It’s easy to make mistakes, so guidance from a professional could make a difference in how much or you pay or don’t pay,” says Rob Cordasco, a CPA and author of A Framework for Growth: Smart Financial and Tax Planning Strategies Throughout the Entrepreneurial Life Cycle.
It’s also easy to get behind on paying what you owe because, unlike someone who works for an employer, a self-employed person doesn’t have taxes held out of each paycheck. That means they need to set aside money so they can make quarterly estimated tax payments to the IRS, Cordasco says.
Tips For The Self-Employed
A few other tips worth knowing for the self-employed, Cordasco says, include:
Be sure to deduct business expenses – but be careful about what’s allowed.
If you were accustomed to working for a business, someone else worried about what business expenses were deductible. But as a self-employed person, that responsibility now falls to you, Cordasco says. One possibility could be a deduction for a home office if you have a dedicated part of your house that you use for work. In addition, deductions are allowed for supplies and travel expenses, although Cordasco notes that there are rules that apply to such things.
It is also possible to deduct 50 percent of the cost of a business meal, but there also are rules attached to that. For example, you or someone you employ need to be physically at the meal, Cordasco says. Also, you can’t just deduct a random lunch that happens during business hours, but you can deduct a meal if you are traveling on business or you take a client out for a meal. For all business expenses, it’s imperative to keep good records so you can make your case if the IRS challenges something, Cordasco says. It’s also important to make sure you deduct only legitimate business expenses. A hobby that you make money from occasionally, but don’t operate as a business, could create red flags at IRS headquarters, he says.
Plan for retirement.
It’s common for people who work for corporations to have a retirement plan they can contribute to, with money coming out of their paycheck and the employer sometimes adding a matching amount. A self-employed person doesn’t have that system available, but they can still create a retirement plan of their own, Cordasco says. One option for doing that would be to simply open a traditional IRA or a Roth IRA and make regular contributions. But IRS rules also permit self-employed people to set up a SEP-IRA, which allows for larger annual contributions. SEP stands for simplified employee pension. You can contribute up to 25 percent of your net earnings from self-employment up to a maximum contribution of $61,000 for 2022. By comparison, annual contributions to traditional and Roth IRAs are generally limited to $6,000.
Be diligent with recordkeeping.
It’s critical to keep good records that track your income and expenses in case you are audited by the IRS or a state or local tax authority, Cordasco says. Without good records, you won’t be able to give an accurate accounting of your income, which means come tax filing time you could face one big confusing mess, he says. Also, as mentioned previously with those expenses, if you can’t document them you can’t deduct them.
These are just a few of the many issues a self-employed person can encounter, Cordasco says.
“While you might be able to handle your needs on your own, it’s a good idea to consult with a professional who can provide guidance on what’s allowed, what’s not, and a host of issues you might not have thought about,” Cordasco says. “Beyond that, the tax laws are constantly changing so you need to make sure you have the most up-to-date information.”
About Rob Cordasco
Rob Cordasco (www.cordasco.cpa), author of A Framework for Growth: Smart Financial and Tax Planning Strategies Throughout the Entrepreneurial Life Cycle, is the founder of Cordasco & Company, P.C., a boutique Certified Public Accounting firm. Cordasco is a CPA with more than three decades of experience. He holds a bachelor’s degree in accounting from Spring Hill College in Alabama.