Taking your skillset and using it to start your own business or professional service requires bravery and planning. It also requires that you learn about many different areas of the law.
As a self-employed individual taxpayer, you will have different tax responsibilities than you have as an employee. If you don’t learn about these early in your transition from employee to your own boss, you could wind up making mistakes that lead to big tax penalties.
You have to retain funds for all of your own employment taxes
There are tax obligations that come with work including employment and Social Security taxes, as well as federal and state income taxes. There will be no one to calculate these taxes on your behalf must you hire a professional to do so. There will also be no one to remind you to hold money out of every paycheck or completed invoice for taxes.
It is your obligation to understand the taxes you have to pay and to retain sufficient funds for those taxes. You will have to pay a higher tax rate as a self-employed individual than you previously paid as an employee, as your employer would have paid certain taxes on your behalf. You will now need to pay the equivalent of those taxes via self-employment taxes.
If your taxes come due and you don’t have enough money set aside to pay them in full, you may wind up needing a payment plan through the IRS, which could mean big penalties and interest on the unpaid amount.
You have to make estimated quarterly payments
You don’t just have to send a tax return by April 15 every year when you work for yourself. You have to send in quarterly taxes four times a year. In addition to filing your income tax return on April 15, you will also have to submit your first or early estimated tax payment for the current year. You will also have taxes due on June 15, September 15, and January 15 every year.
If you don’t send in your quarterly estimated taxes and pay either the full tax responsibility of your prior filing year or 90% of your current year’s tax obligations, you could wind up paying penalties due to your underpayment of estimated taxes.
Learning about the unique tax considerations for those who are self-employed and also about deductibles and certain benefits can help you stay in compliance as you transition to running your own business.