Doing your tax return is hard enough when you are a regular employee entering income from the W-2 you get from your employer. When you are self-employed, as many more of us are today, taxes can be even harder to figure out. You don’t want to end up with a surprise tax bill because you didn’t realize that part of your hard-earned money was taxable.
What are the basic things you need to understand about taxes when you work for yourself? First, if you’re not sure that you are actually considered an independent contractor, our Investopedia article can help you confirm that status. Once you’re sure, follow these steps to be ready when tax season rolls around.
Classify Yourself
When you’re self-employed, you can fall into one of several tax categories:
Self-employed consultant
Sole proprietor
LLC member (LLC owners are called members)
S-Corp owner
Corporation owner
Let’s break these down. If you pick up occasional work here and there – like if you help out with events once in a while, getting paid $500 a crack – but you don’t really have a “business,” you’re going to get a 1099-MISC showing what that company paid you that year. The income reported on the 1099-MISC will go to the IRS with your Social Security number attached to it just as income on a W-2 gets sent. In that case, you’ll report that income on line 21 of Schedule 1 of your Form 1040. In this case, you’re not really “in business” but are a self-employed consultant. In this case, you don’t have a special tax number for your business; you just use your Social Security number.
If you have expenses related to that income, and you consider yourself to be in business, then you are a sole proprietor. In this case, you’ll put your business income and deductions on Form Schedule C that goes along with your Form 1040. In this case, you don’t need to have a special tax number for your business; you can just use your Social Security number. However, as a sole proprietor, you may want to get an EIN, which is a special tax number for a business.
If you’ve decided to create an LLC for your business, then you will need to do two tax forms each year: Form 1040 and Form 1065. You’ll put your business income and expenses on Form 1065. From the 1065, forms called K-1s will be generated. Those K-1s will go to each member of the LLC and will distribute the profit or loss proportionately to their ownership. So if the LLC’s net profit is $8,000 and there are 4 members, each member’s K-1 will show a $2,000 profit that will get added to that person’s Form 1040 as business income, adding to that person’s AGI. If the LLC’s net total for the year is a loss of $8,000 then each member would be able to take $2,000 off their AGI. In this case, you will have applied for an EIN for your business and will use it for business tax purposes on your 1065; the K-1 generated from the 1065 will use your Social Security number and tell you where on your personal 1040 you should put the income. One thing to remember about Form 1065 – no tax is paid by the company with that form. Instead, any tax that might be due will be paid by the individual members on their personal 1040s.
If you incorporated your business as an S-corporation, you’ll still do two tax forms, but in this case you (or your tax pro) will complete the Form 1040 and Form 1120S. Form 1120s is like Form 1065 in that K-1 statements are generated from the net profit or loss in a manner similar to the 1065 and an EIN is used. Like the 1065, no tax is paid by the company with that form. Instead, any tax that might be due will be paid by the individual members on their personal 1040s.
If you chose to incorporate your business as a C Corporation, you’ll complete Form 1120 using the company’s EIN. Depending on circumstances, you may or may not have information from your business that transfers to your personal 1040 tax return. Unlike the 1065 or the 1120S, tax may be due with the 1120 and would be paid by the corporation not by an individual.
Provide the Correct Number to the Entity You Work For
When you sell an item or a service in the course of doing business, you want to be sure to provide the correct tax id number. As a consultant, you’ll complete a W-9 to show the entity you are working for how to pay you and to provide the tax id number (either your SSN or your company’s EIN) through which the IRS will track income you receive. The entity or person who employs you (or you through your company) will also issue you a 1099-MISC that shows what you were paid that year by that entity. As a contractor, you might have one or more 1099-MISC from many different entities from whom you worked that year; you’d enter all of these in the appropriate form as business income.
Conclusion
This article touches only briefly on tax consequences of being in business for yourself. In addition to understanding how to classify your self as a self-employed person, you can read more about tax benefits of being self-employed, estimated tax payments when you’re in business for yourself, gig economy definitions of employee vs. contractor, tips on hiring when you’re in business for yourself, and how the new Tax Act can help you and your business save on taxes.