Finance 101 for eWorkers: Tax Basics
Kristin Kane writes for www.ework.com – a Ms.Money partner.
Succeeding as an independent professional requires immense talent and skill. But even if you are the best Web developer north of the Rio Grande, you also need to know how to run a business. In this first installment in a series of articles covering financial management for independent professionals, we will address one of the crucial financial issues facing independents–their dues to Uncle Sam.
The IRS requires independent professionals to pay a so-called ‘self-employment tax’ of 15.3% to cover the social security and Medicare taxes. Ordinarily an employer picks up half the tab for these taxes, but self-employed people pay the entire amount out-of-pocket. Even if you hold a regular job and only moonlight as an independent, you may still have to pay self-employment tax. All self-employment earnings totaling over $400 are subject to this hefty tax. Fortunately, independents get to deduct half the amount they pay in self-employment tax when they file their income taxes on April 15.
The federal income tax is what is known as a ‘pay-as-you-go’ tax, meaning that it’s due throughout the year. For people in traditional jobs, employers withhold the appropriate amount and send it directly to the IRS on behalf of the employee. But if you expect to owe at least $1000 in income tax on April 15, the IRS requires you to make quarterly payments of estimated taxes. Consequently, most independent professionals pay their tithes to the government four times a year. Independents who also hold traditional jobs can avoid paying estimated taxes by asking their employer to withhold an additional amount from each paycheck.
Deducting ordinary business expenses is an important tool in keeping your taxes down. Office supplies, postage, phone calls, travel expenses, client lunches–and yes, even car mileage–are deductible. In addition, the following larger deductions will help keep the spring in your step.
Home Office. You may be able to deduct the cost of maintaining a home office. In order to qualify for the deduction, you must use your office “regularly and exclusively” for your business. If you keep a spare bed or TV in your office, the IRS may view that as evidence that the space is not used exclusively for business. Your office does not necessarily need to be a separate room. It can be part of a room, or even a closet. What matters is that its boundaries are defined.
Additionally, your office must be one of the following: your primary place of business, a freestanding structure not attached to your home, or a place where you meet with clients.
Once you have specified the location and dimensions of your office, you are entitled to deduct the cost of maintaining that portion of your home. For instance, if your office space takes up 20% of your home, you can deduct 20% of your rent or mortgage, as well as 20% of the other costs of maintaining your home, including the utility bills.
Health Insurance. Health insurance, a big-ticket expense for independent professionals, fortunately translates into a big income tax deduction. Self-employed people are entitled to deduct 60% of the amount they pay for health insurance for themselves and their families. This rate is scheduled to rise to 100% by 2003.
Thorough record-keeping is the bedrock of sound financial management. With the IRS audit rates significantly higher for independent professionals than for the general population, financial records can make or break a business. So hold on to those receipts. Additionally, many tax advisers suggest that you keep a journal of your business activities and expenses.
Keep in mind that your state and local tax authorities may also have specific requirements for self-employed people. If this is your first year as an independent, you will probably want to get some help from a professional tax adviser. The good news is that mastering your taxes gets easier each time you file. And most independents agree that it’s a small price to pay for freedom.