Self-employment can be a great thing. You get to set your own schedule, be your own boss and make all management decisions that need to be made. It can be great, but ask almost any self-employed individual if it involves a lot of responsibility and they'll quickly respond with a "yes." Taxes are one of those responsibilities that can cause more than a headache.
For those who earn an income under a W-2, taxes can be complicated enough with allowances and bonuses, but at least some of the guesswork is taken care of automatically through withholdings each pay period. For those who are self-employed, the guesswork is all in their hands from keeping track of deductible business expenses to estimating taxes. Here are some tips that can help the self-employed avoid tax audits and penalties.
Paying estimated taxes throughout the year not only helps avoid a big tax liability but also prevent penalties that can follow in many situations. But how much do you pay to the IRS after each quarter? What about state? The self-employed don't have a guaranteed salary, but getting "in the ballpark" can be done through looking at past records and adjusting projections as needed. One good way to "estimate" is to simply set aside from 30 to 40 percent of your income.
Next, records, records, records when it comes to business expenses. Detailed records can make all the difference and really help. Keeping business funds separate from personal funds makes this task much easier and clear. This means separate checking accounts, credit cards and even phone service contracts. Accurate records make accurate estimates for business expenses easier.
When all estimates are made, subtract the deductible expenses from the projected income. This is the annual income. Simply divide this number by four and that is a good quarterly income estimate.
Of course, consulting an experienced tax attorney can help in not only making estimates but also help self-employed understand complex tax laws and act as a knowledgeable advocate who understands your individual situation when facing an audit or penalties.
Source: The Wall Street Journal, "A Guide to Withholding," Steve Rosenbush, Feb. 23, 2013