With the uncertainties over H-1B instructions/green card clarifications and ample opportunities for anyone with monetary resources to opt for the scheme “EB-5 program,” the need to learn the simple instructions contained under self-employed persons for tax purposes is essential and helpful to face the uncertain economic future.
Let us learn the basics. The main source for our guidance is, as usual, the Internal Revenue Service website, quoted as under:
https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
Are you self-employed?
Yes, if you are a sole proprietor, a contractor, a member of a partnership that carried on a trade or business, or otherwise in business for yourself (including in a part-time business or as a gig worker).
What are your tax obligations as self-employed?
You are required to file an annual income tax return and pay estimated taxes quarterly.
Let me amplify this from a quote from the IRS website.
“Self-employed individuals generally must pay self-employment (SE) tax as well as income tax. SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. In general, the wording ‘self-employment tax’ only refers to Social Security and Medicare taxes and not any other tax (like income tax).”
Let me use the term SE individual in place of self-employed individual.
If you are an SE individual, before calculating the SE tax and income tax, you will find out the net profit or loss from your business, which is easily done by deducting your business expenses from the business income. If the figure is positive, it indicates a net profit and becomes a part of your income on page 1 of Form 1040 or 1040-SR.
In case the expenses overtake the income, the difference is a net loss. In that situation, you can deduct your loss from gross income on page 1 of Form 1040 or 1040-SR.
How does one pay the quarterly payments?
As a self-employed individual, estimated tax is the method used to pay Social Security, Medicare, and income taxes.
This is done since, as an employer, you do not withhold these taxes.
Form 1040-ES, Estimated Tax for Individuals (PDF), is used to figure these taxes. Form 1040-ES contains a worksheet that is similar to Form 1040 or 1040-SR. You will need your prior year’s annual income tax return in order to fill out Form 1040-ES.
How do you file your tax return?
You will use Schedule C, Form 1040, Profit or Loss from Business (Sole Proprietorship).
To file your annual income tax return, you will need to use Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship), to report any income or loss from a business you operated or profession you practiced as a sole proprietor, or gig work performed. Schedule C instructions (PDF) may be helpful in filling out this form.
In order to report your Social Security and Medicare taxes, you must file Schedule SE (Form 1040 or 1040-SR), Self-Employment Tax (PDF).
You may have to use the income or loss calculated on Schedule C to calculate the amount of Social Security and Medicare taxes you should have paid during the year.
Let us learn the instructions for Schedule SE from the IRS website.
https://www.irs.gov/pub/irs-pdf/i1040sse.pdf
Some important instructions from the above site are reproduced below.
You must use Schedule SE (Form 1040) to figure the tax due on net earnings from self-employment. It is a matter of interest to know that the Social Security Administration (SSA) uses the information from Schedule SE to figure your benefits under the Social Security program.
You must file Schedule SE if the amount on line 4c of Schedule SE is $400 or more, or you had church employee income of $108.28 or more. (Income from services you performed as a minister, member of a religious order, or Christian Science practitioner isn’t church employee income.)
You must also pay SE tax on your share of partnership income or guaranteed payments.
The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for Social Security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).
Under Section 2042 of the Small Business Jobs Act, a deduction, for income tax purposes, is allowed to self-employed individuals for the cost of health insurance. This deduction is taken into account when calculating net earnings from self-employment.
Various interesting situations arise. Some of them deserve active consideration.
If you are a U.S. citizen or resident alien living abroad and earning self-employment income, you must pay SE tax, and it is interesting to know that foreign earnings from self-employment can’t be reduced by your foreign earned income exclusion while computing SE tax.
What about a non-resident alien?
If you are a self-employed non-resident alien living in the United States, you must pay SE tax if an international Social Security agreement in effect determines that you are covered under the U.S. Social Security system.
If you have more than one business as a self-employed person?
Your combined net earnings from all businesses, with the loss wiping out the income, and then filing the SE tax schedule with due SE tax is the solution.
What about joint returns?
Kindly show the name of the spouse with self-employment income on Schedule SE. If both spouses have self-employment income, each must file a separate Schedule SE.
Please also include the total profits or losses from all businesses on Form 1040 or 1040-SR.
Yes, please enter the combined SE tax on Schedule 2 (Form 1040), line 4.
What about qualified joint ventures as husband and wife?
If you and your spouse materially participate as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make a joint election to be taxed as a QJV instead of a partnership.
To make this election, you must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your respective interests in the venture.
Each of you must file a separate Schedule C or F. On each line of your separate Schedule C or F, you must enter your share of the applicable income, deduction, or loss.
Further, each of you must also file a separate Schedule SE to pay SE tax, as applicable.
To understand the details of SE tax, one must clearly look into Schedule C, the form which has attracted continued attention of the IRS for extensive underreporting of income of a business.
Instructions on Schedule C
Let us look at the IRS website on this form as under.
https://www.irs.gov/pub/irs-pdf/i1040sc.pdf
Some basics of the above schedule may be incorporated below.
Profit or Loss from Business
The above website does clear most of our doubts/clarifications needed, as under:
In American taxation, “Form C” most commonly refers to Schedule C (Form 1040), Profit or Loss from Business, which is used by sole proprietors and single-member LLCs to report business income and expenses.
IRS Schedule C (Form 1040)
Purpose: Schedule C is attached to your personal U.S. Individual Income Tax Return (Form 1040) to calculate the net profit or loss from a business you operate as a sole proprietor or single-member LLC.
Who Files: You must file Schedule C if you are a sole proprietor or single-member LLC (unless you elected to be taxed as a corporation) and meet criteria such as your primary purpose for the activity is income or profit, and you are involved with continuity and regularity. This includes many freelancers, independent contractors, and gig workers. Active involvement in running the business or providing expertise to earn income for the business matters the most. Just lending a name does not entitle one to get the benefits. It has been frequently observed from periodical inspections/investigations by the IRS that this form has several times been misused to report less income. If frequent loss is reported under this schedule, the IRS may disallow its usage for the taxpayer, since one does not run a business continuously at a loss and the basic purpose of any business is to earn income.
Thousands of filings of Schedule C have given millions of data points to assess whether a genuine business venture does function. Unusual reporting of excessive expenses definitely attracts the attention of IRS computers, and later the necessary actions do follow.
Information Reported: The form requires details about your business’s income (e.g., from Form 1099-NEC), expenses (e.g., advertising, supplies, home office deduction, vehicle expenses), cost of goods sold, and ultimately your net profit or loss.
Related Forms: The net profit calculated on Schedule C is generally used to figure your self-employment tax (Social Security and Medicare) on Schedule SE.
With the vast changes in the notion of self-employed persons, it is time to learn the vast detailed knowledge obtained over the decades.
Some important information is given below.
Are you an independent contractor?
People such as doctors, dentists, veterinarians, lawyers, accountants, contractors, subcontractors, public stenographers, or auctioneers who are in an independent trade, business, or profession in which they offer their services to the general public are generally independent contractors. However, whether they are independent contractors or employees depends on the facts in each case.
The general rule is that an individual is an independent contractor if the person paying for the work has the right to control or direct only the result of the work and not how it will be done. The earnings of a person who is working as an independent contractor are subject to self-employment tax.
What about a sole proprietor?
A sole proprietor is someone who owns an unincorporated business by themselves. You are also a sole proprietor for income tax purposes if you are an individual and the sole member of a domestic LLC, unless you elect to have the LLC treated as a corporation.
Limited Liability Company
It is interesting to know that an LLC is an entity formed under state law by filing articles of organization. Generally, for income tax purposes, a single-member LLC is disregarded as an entity separate from its owner and reports its income and deductions on its owner’s federal income tax return. For example, if the single-member LLC is not engaged in farming and the owner is an individual, he may use Schedule C.
Conclusion
Self-employed persons constitute the backbone of American innovation, creating opportunities for youngsters to take up projects of their liking, limited to less paperwork, with the latest technology available to run a business on a shoestring budget and later convert it into an LLC or LLP with ample scope for growth and prosperity.
With proper guidance from an active CPA, any entrepreneur can succeed in their business venture, provided proper rules are followed, books of accounts are well laid out, and the required taxes of all kinds are paid. Invariable issues do arise when regular business as a self-employed person violates even the basic tax rules and avoids paying taxes when needed.
Caution
The basic purpose of this article is to show some basic knowledge of taxation which, if properly used, will benefit the self-employed person. However, this is not intended to give tax consultation, and it is definitely advisable to consult a CPA for direct tax consultation.
Refrences:
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https://www.irs.gov/businesses/small-businesses-self-employed/self-employed-individuals-tax-center
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https://www.irs.gov/pub/irs-pdf/i1040sse.pdf
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https://www.irs.gov/pub/irs-pdf/i1040sc.pdf
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