Solopreneur 2018 Tax Overview
Are you a freelancer or an independent contractor? Do you have a side gig? Then this Solopreneur 2018 Tax Overview applies to you.
I know, taxes are boring and confusing, but they can’t be overlooked, especially if you are just starting a business for yourself. And it’s not all bad news in 2018. There are some changes in the tax law that could help you save a bundle. But first, let’s go over some basics.
What’s Self- Employment tax?
If you are a freelancer, independent contractor or a side gigger who makes over $400 a year, you are considered self-employed and have to pay self-employment tax (SE tax) out or your own pocket in addition to income tax. SE tax is Social Security and Medicare tax that is usually withheld from your paycheck when you are an employee.
Why do I have to pay SE tax?
When you are an employee, you and your employer both are responsible for paying Social Security and Medicare taxes. This is known as FICA withholding. (FICA stands for “Federal Insurance Contributions Act.”) The employer pays half of the Social Security and Medicare tax, and the other half magically disappears from your paycheck. On the other hand, if you are freelancing or doing contract work, even part-time, you are responsible for paying the Social Security and Medicare tax out of your own pocket. If you made more than $400 in 2018, you must pay this SE tax.
If you made more than $400 on your side gig this year, you are on the hook for self employment taxes as a sole proprietor.
What’s a Sole Proprietor?
A Sole Proprietorship is the easiest and least expensive way to set up a business. A Sole Proprietorship doesn’t require any formal filings. It’s an unincorporated business with one person (or a married couple) as owner. In fact, if you are already freelancing without having set up a formal business entity, you are already a Sole Proprietor.
If you are freelancing without a formal business set up, you are already a Sole Proprietor.
The IRS treats a Sole Proprietorship as a “disregarded entity” for tax purposes. This is also referred to as a “pass-through” entity. This means that the business doesn’t pay the taxes. Instead they “pass-through” to the owners. You are responsible for reporting your income and deductible business expenses when you file your personal taxes on your Form 1040. But to do that, you need a couple more forms: a Schedule C and a Schedule SE.
Do you have a Single Member LLC?
If you have a Single Member LLC and have not filed to be taxed as a corporation, you are also considered a “pass-through” entity for tax purposes. Just like a Sole Proprietorship, you will also report your income to the IRS using a Schedule C, Schedule SE and a 1040, at least. (This applies to partnerships and S Corps as well.) If someone else set up your LLC for you, and you’re not sure whether you have elected to be taxed as a corporation by filing Form 8832 – Double check! This is important!)
So, how do I file SE taxes?
Basically, you have to calculate the amount of your self employment tax using a Schedule SE that you will file with your taxes. Once you have calculated the SE tax amount, you will enter it on your Form 1040. But in order to to calculate your SE tax, you need to fill out a Schedule C first. A Schedule C helps you walk through the amount of your business’ profit or loss in order to determine your net income, and you need that figure for your Schedule SE.
What’s a Schedule C?
Schedule C – Profit or Loss from Business is a form that helps you figure out the amount of money you made or lost overall from your business activities throughout the tax year. This is also where you get to deduct business expenses that will affect the final figure you will use to determine both your SE tax and your income tax. So, a Schedule C is pretty important.
The final amount (net amount) of money you made or lost goes on line 31 of your Schedule C, and then it is entered on your Form 1040*. It is also entered on line 2 of Schedule SE to determine your SE tax. This is why you are going to want to complete your Schedule C first.
The lower the amount of net income you made, the lower your SE and income tax will be.
What’s a business deduction?
A business deduction is an amount of money you spent for a qualified business expense that the IRS allows you to subtract from your adjusted gross income (AGI) which makes this figure lower. The lower your taxable income, the lower your income tax and self employment tax. This is a good thing.
What business deductions can I take?
Being a Solopreneur opens you up to a lot of potential business deductions you can take to lower your tax liability that you might not be aware of. Some examples of business deductions may require a bit of preparation ahead of time. So to help give you a heads up, we’ve laid them out here:
If you work out of your home, you can deduct a relative amount of your home’s expenses for that portion of your home that you use regularly (and only for) your business. There are two different ways to figure this deduction, so do your math and choose the one that gives you the best option:
1- The easy way – You can deduct $5 for each square foot, up to a maximum of 300 square feet. ($1500) If your home office is larger than 300 square feet, use the less easy way.
2 – The less easy way – Determine what percentage of your house is used for your home office. For example, if the square footage of your entire house is 2000, and your home office takes up 400 square feet, you are looking at 20% of your homes total expenses.
The home office deduction allows you to deduct rent, mortgage, utilities and other expenses. To figure out your home office deduction, you need to use Form 8829, then you will enter this deduction on line 30 on Schedule C. Definitely check out the IRS Publication 587 Business Use of Your Home to make sure you are drawing within the lines.
If you use your car to meet clients, transport goods, meet vendors or any other trips related to business, there are a couple of ways you may take this deduction.
1- The easy way – In 2018 you can deduct 54.5 cents/mile for the business use of your car without having to itemize gas, insurance, depreciation, and maintenance. You’ll need to keep track of your business mileage to do the math for this deduction.
2 – The less easy way – You can deduct the business percentage use of the following expenses: depreciation, licenses, lease payments, registration fees, gas, insurance, repairs, oil, garage rent, tires, tolls, and parking fees. You’ll add up all of these expenses and calculate what percentage of your total mileage was for business use and apply that percentage to take the deduction. Check out IRS Publication 463 Travel, Entertainment, Gift and Car Expenses for more information. (This publication also covers additional deductions that are listed below.)
Work Related Education
Part of being a Solopreneur often involves continually updating and improving skills sets as Solopreneurs often have to wear many hats. If you took any courses to maintain or improve the skill sets you need in your current business, those expenses may be deductible. Check out IRS Publication 970 to make sure you can take the deductions. (Note: there are quite a few other educational credits in this publication that may apply to you as well if you have been studying up, so look out for them.)
Pay your future self and deduct it from your taxes? Absolutely! If you are a Solopreneur without a retirement savings plan such as a Solo 401(k) or SEP IRA, you’re missing out on the best of both worlds big time. It isn’t too late to take this deduction for 2018! Not only will you lower your taxable income by your deductions, you will be saving for your retirement. Tip: Open an IRA online with Swell for only $50 and they will contribute an extra $50 to your retirement account.
If you are a Solopreneur without a retirement savings plan such as a Solo 401(k) or SEP IRA, you’re missing out on the best of both worlds big time.
Solo 401(k) Deduction: Contributions up to $55,000 for 2018 or 100% of earned income, whichever is less. For more, check out Solopreneur Retirement: Pay Yourself First.
SEP (Simplified Employee Pension) IRA Deduction: The lesser of contributions up to $55,000 or 25% of net self-employment earnings. For more, check out Solopreneur Retirement: IRAs for Solopreneurs.
A Long List of Additional Deductions
This is by no means an exhaustive list, but if any of these trigger you, be sure to look into whether you can deduct them or not:
- Start-up Costs – If you invested to set up your business in 2018, you may be able to deduct up to $5,000 of this expense. Over $5,000 is considered a Capital Expense and amortized over time.
- Health Insurance – You may be able to deduct premiums for yourself, spouse, dependents and children under 27.
- 1/2 of SE tax – Remember that SE tax? The IRS lets you deduct the employer part of it which helps soften the blow of having to pay both.
- Student Loan Interest – Still paying off those student loans? Don’t forget to check if you can deduct the interest.
- Advertising – This means your website creation and maintenance costs. Marketing, promotions and any ads you buy. It also includes promo and branded items like flyers, T-shirts and keychains. Nice, right?
- Professional services – Any tax prep, legal counsel, accounting, bookkeeping incurred during the tax year may be deducted.
- Office supplies – If purchased and used within the tax year, deductible.
- Unpaid invoices – It sucks when a customer bails on an invoice, but if you can prove that the invoice is uncollectible, you may be able to write it off.
- Bank fees – Any ATM, bank fees or wire transfer fees incurred doing business. Tip: It helps to set up a separate business account to keep track of these for tax time.
- Interest on business credit cards or loans – If you use a credit card for business or have taken out a small business loan, you can deduct the interest charged.
- Charitable donations – Do you give 1% of your profits to a charity of some kind? This applies as well.
- Trade shows and conventions – You may be able to deduct your travel expenses if you attend for business.
- Business travel – Yes, there are deductions for business travel within and outside of the US, but there are some restrictions on the amounts and kinds of deductions. For example, you can only deduct 50% of your meals and you can’t deduct frequent flyer miles, so look into this carefully.
2 of the Coolest Tax Changes for Solopreneurs in 2018
*Form 1040 is changing dramatically for 2018. The final form is not even available yet but you can take a look at the 2018 Form 1040 draft. The 1040EZ and 1040A are gone! The new form is supposedly much smaller. However, reportedly there are a plethora of new Schedules to be issued. (Oh, yey!) Keeping this in mind, depending upon your circumstances, you may need additional forms to file that haven’t even been released yet. (So, we can’t even write about them.) Fun, right?
1) The 20% Deduction for Pass Through Entities
You may have heard about The Tax Cuts and Jobs Act (TCJA), a new tax law for 2018, and how it lowers the taxes for corporations. Well, there is also a new deduction for pass-through entities. This means you Sole Proprietors and Single Member LLCs! Here are some changes that may affect you in a good way:
The TCJA creates a brand new tax deduction for all “pass through entities.” Sole Proprietors, Single Member LLCs, partners in a Partnership and S Corps may be able to deduct an amount up to 20% of their net business income in addition to all their other business deductions.
To put it simply, if this deduction applies to you, you will only be taxed on 80% of your net business income and be able to itemize deductions.
Here’s how it works:
Income below $157,000 ($315,000 married)
- You operate the business as a sole proprietor, LLC owner, partner in a partnership, or S corporation shareholder, and
- Your total taxable income for the year from all sources after deductions is below $315,000 if married filing jointly, or $157,500 if single.
You may be able to deduct 20% of your net business income.
This deduction is reduced if your income exceeds the $157,500/$315,000 limits. If you make above $207,500/$415,000, there are special rules that might allow some of the deduction. There are also some exceptions to this deduction that apply to people in certain professions such as doctors or lawyers. But for those of you Solopreneurs who are consultants, marketers, coaches, and writers in the gig economy, this could mean big tax savings if it applies.
2) Bonus Depreciation
When you buy equipment needed for your business, you can get tax deductions for buying and using it. This is considered a Capital Expense in the form of depreciation which is generally the expense of buying and using property over time, so the depreciation is usually taken over a period of years. But bonus depreciation allows your business to take an immediate tax deduction on property for the year in which you actually buy it and put it to use.
The TCJA creates a brand new bonus depreciation schedule that allows you to take a 100% bonus depreciation for 2018. That means if you purchase an asset for your business such as business equipment, computers, or software, and begin to use them in 2018, you can deduct 100% of their depreciation for 2018. You will need to use Form 4562 to report the deductions. As most Solopreneurs rely on expensive hardware, and software, this could save a bundle.
Wrap up: 10 Steps You Can Take Today!
Yes, taxes are a pain in the ass. But we are stuck with them. They are confusing and time consuming so the sooner you bone up on your tax know how, the easier it will be for you to learn to save the most that you can. Even if you decide to use a tax professional, (deductible, remember?) understanding where you can save is only going to benefit as you scale and help you plan ahead for future expenses. So, to wrap up:
- Get your paperwork in order: Start to tally up your business income and losses.
- Prepare to take deductions: Begin adding up your home and vehicle expenses. Measure your home office, decide how to quantify your business mileage. Add up any interest on business banking and student loans. Add up your health insurance premiums.
- Open a retirement account: Start contributing now to lower your tax liability for 2018.
- Gather receipts for business expenses: Check to see if you can take the 100% bonus depreciation on business assets you purchased and started using in 2018. Did you buy a new laptop this year? Software? List any office supplies you can deduct. Add up your website costs: hosting, ongoing services, Facebook ads, etc…
- List any online courses you took to level up your skills: If they maintained or improved your ability to do business in your niche, take advantage of the education deduction. Did you hit up Udemy? Coursera?
- Download your bank statements ahead of time: Don’t wait till the last minute to sort through statements for travel and purchases to support your deductions. Get a head start.
- Download the IRS Tax Guide for Small Businesses: Yes, this is the 2017 version, but you can get a general idea.
- Download the IRS Business Expenses Publication 535: Again, the 2017 version, but you can start to dig in on business deductions.
- Think about hiring a tax professional: Remember, you can deduct this expense later and may sleep better at night. Also, a good one will find deductions and credits that you may overlook.
- Get ready to save some money! – Solopreneurs work hard for their money. While taxes indeed suck a ton of precious time, think of the money saved as money earned.
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