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Being your own boss can be incredibly rewarding. But it also comes with a lot of responsibility, and when something goes wrong, there’s only the boss — that’s you! — to blame.
One aspect of self-employment that can trip you up is doing your taxes. If you’re new to self-employment, you may want to save money by doing your own taxes. But making a mistake when it comes to your filing can cost you — in some cases, a lot more than using a professional tax preparer might have.
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Here are some of the biggest tax pitfalls for self-employed people, and how to avoid them.
Estimated taxes
Imagine Jess, who made the leap into self-employment five years ago as a freelance photographer. She’s been doing her taxes herself, using tax software, but she wasn’t aware that, as a self-employed person, she was required to pay estimated taxes quarterly.
Now, she’s gotten a bill with a $9,000 penalty from the IRS.
It’s a huge hit, and once Jess talked to a tax professional, she realized she was also missing out on deductions she could have made for her business and setting up a SEP IRA.
According to the IRS, one of the common mistakes that small business owners make when it comes to taxes is underpaying estimated taxes (1).
If you’re self-employed, you typically have to pay quarterly estimated taxes. Estimated taxes have to be paid throughout the year, in the same way that an employer withholds taxes from employees’ paychecks and remits them to the IRS (2).
Estimated taxes pay your income tax and other types of taxes such as self-employment (SE) tax, which “is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners,” the IRS says (3).
Like the imagined scenario of photographer Jess, if you don’t pay enough in your estimated payments, you could face a penalty.
“Generally, most taxpayers will avoid this penalty if they owe less than $1,000 in tax after subtracting their withholdings and credits, or if they paid at least 90% of the tax for the current year, or 100% of the tax shown on the return for the prior year, whichever is smaller,” according to the IRS (2).
You’ll also face penalties for late quarterly payments, even if you get a refund on your tax return (2).
For small business owners who have employees, another error that can cost you is not dealing with depositing their taxes correctly.
If you have employees, you must deposit the taxes you’ve withheld, and your share of those taxes as the employer, using electronic fund transfers. “If those taxes are not deposited correctly and on time, the business owner may be charged a penalty,” the IRS says (1).
Another big mistake for self-employed people and small business owners is not keeping your expenses separate.
Setting up a bookkeeping system that keeps your personal expenses out of the mix will be a big help when it comes to figuring out your taxes.
The IRS notes that while it can “be tempting to use one credit card for all expenses especially if the business is a sole proprietorship,” this can cause accounting headaches.
Not only can it be difficult to track what’s what, it could lead to mistakes on your deductions, “and become a problem if the taxpayer or their business is ever audited,” the IRS says (1).
It’s also important to get familiar with the deductions you can make as a self-employed person. These deductions include your home office (4), your self-employment tax (5), retirement plan contributions, health insurance premiums (6) and vehicle use (7). There’s also the qualified business income (QBI) deduction, which many sole proprietor businesses may be eligible for (8).
Talk to an expert
It’s a lot to become familiar with. If you are new to being self-employed, or you’re not sure you’ve got a handle on taxes, even after a few years of being your own boss, bringing in a professional could pay for itself.
A financial advisor or tax expert can help you file correctly, identify deductions you may have missed and build a tax strategy that works year-round instead of scrambling every April.
They can also help you legally reduce what you owe by timing income, maximizing deductions and taking advantage of tax-deferred accounts that fit your situation. If you’re looking for help, platforms like Advisor.com can connect you with a financial professional who can tailor a strategy to your goals.
Here’s how it works: Simply enter a few details about your finances, and Advisor.com will comb through its roster and connect you with a qualified expert best-suited for your unique needs. Their network comprises fiduciaries, who are legally required to act in your best interests.
Finding the right advisor isn’t always easy — there’s no one-size-fits-all solution. That’s why Advisor.com lets you set up a free initial consultation, with no obligation to hire, to see if they’re the right fit for you.
Invest in tax-advantaged assets
Working for yourself also means paying both the employer and employee share of payroll taxes. The current self-employment tax rate is 15.3% (9), and it applies to 92.35% of your net earnings (10). The good news is that you can deduct half of that self-employment tax “above the line” on Form 1040, reducing your adjusted gross income before your income tax is calculated (11).
Because you’re responsible for funding your own future Social Security and Medicare benefits, taxes can take a bigger bite out of every dollar you earn.
The silver lining? You don’t have to rely solely on deductions to reduce your tax bill. Contributing to tax-advantaged investments and retirement accounts can help lower your taxable income now while giving your savings more room to grow over time.
Open a gold IRA
If you’re looking for a tax-efficient retirement strategy, a gold IRA could be worth a closer look. Depending on the type of account you open, you may be able to contribute pre-tax dollars (12), reducing your taxable income today while deferring taxes until you begin making withdrawals in retirement.
Opening a gold IRA comes with other advantages too. On top of the potential tax savings, gold has earned a reputation as a store of value during periods of inflation and market uncertainty.
Today, you can combine the recession-resistant properties of the precious metal with the tax advantages of an IRA by opening a gold IRA with the help of Priority Gold.
And with Priority Gold’s platinum package, you can even get free account setup and insured shipping and storage for up to five years. Plus, you can also roll over your existing IRA or 401(k) into a precious metals IRA with Priority Gold — tax and penalty-free.
The best part? You can download Priority Gold’s wealth preservation guide for free and get up to $10,000 in complimentary silver upon making a qualifying purchase. Just keep in mind that gold is usually best used as one part of an otherwise well-diversified portfolio.
Add real estate to the mix
Another investment that can potentially reduce your tax burden is real estate. In addition to generating rental income, investment properties can unlock several tax benefits that aren’t available with other assets.
One example is the 1031 exchange, which allows investors to defer capital gains taxes when swapping one qualifying investment property for another (13). Rental property owners may also be able to deduct rental property depreciation, which can reduce taxable income (14).
Of course, owning rental property isn’t exactly hands-off. Between financing, maintenance and tenant issues, the work can quickly add up.
If you’d rather skip those responsibilities, real estate crowdfunding platforms like Arrived let you invest in shares of rental properties across the country without any of the hassles. And you can get started with as little as $100.
Arrived’s 1031 Exchange Program lets eligible investors defer capital gains taxes while moving into professionally managed rental properties — without the mess of finding replacement properties, coordinating the exchange or becoming a landlord.
The platform also distributes any rental income generated by properties to investors monthly, allowing you to potentially set up a passive income stream without the extra work that comes with managing your own rental property.
Those with more capital on hand can expand beyond short-term residential rentals.
Accredited investors can now tap into this opportunity through platforms such as Lightstone DIRECT, which gives accredited investors access to single-asset multifamily and industrial deals.
Lightstone DIRECT’s direct-to-investor model ensures a high degree of alignment between individual investors and a vertically-integrated, institutional owner-operator — a sophisticated and streamlined option for individual investors looking to diversify into private-market real estate.
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