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The previous tax year was a difficult one for many self-employed individuals, including sole proprietors, independent contractors, and single-person businesses. We previously covered tax filing for small business owners, but what if you are a sole proprietor or self-employed? With the coronavirus pandemic changing a lot of guidelines for tax season this year, we wanted to dive in and cover the basics to know.
This article will examine the impact of provisions specific to single-employee business tax filing in 2020, including:
- filing your tax return,
- COVID-19 tax changes,
- tax deductions,
- and things to remember as a Single-Person Business.
The tax season began on February 12, 2021, and the due date for tax filing is April 15, 2021.
Filing Your Tax Return
According to the IRS website, you are considered self-employed if
As an independent contractor (or freelancer), you will have received Form 1099-MISC for any work completed while sole proprietorships and other self-employed individuals will be filing out Form 1040s – including Form 1040 Schedule C, which determines profit and loss.
You will be responsible for self-employment tax, which is Social Security and Medicare taxes that would typically be withheld by an employer. Self-employment tax (SE tax) is determined using Schedule SE (Form 1040 or 1040-SR), which finds the tax due on net earnings from self-employment. The SE tax rate is 15.3 percent:
- 12.4% for social security (old-age, survivors, and disability insurance)
- 2.9% for Medicare (hospital insurance).
In 2020, the “first $137,700 of your combined wages, tips, and net earnings” are subject to any combination of the Social Security tax. All combined wages, tips, and net earnings are subject to the Medicare tax.
The employer-equivalent portion of your SE tax can be deducted from your adjusted gross income. This would not affect net earnings or the SE tax, it only impacts your income tax.
Self-employment tax and filing a Schedule SE are required if your net earnings are more than $400.
From W-2 to Self-Employed
Unfortunately, during the coronavirus pandemic and economic downturn, many people were laid off and went from being full-time employees to self-employed.
This change may make filing taxes a bit more difficult for two reasons:
- there is a Form W-2 and Form 1040 involved,
- and some taxes will have been withheld already by an employer.
However, Form 1040 includes space (Line 1) to include a Form W-2 and wages, salaries, and tips paid out as an employee. Also, Line 25a is a space to note the federal income tax that was withheld by an employer.
Although this can make tax filing a bit more convoluted than usual, having some taxes withheld already by an employer can reduce the tax liability you have as a self-employed individual. It may also lead to a tax refund!
Living and Working in Multiple States
The coronavirus pandemic also changed where many people worked and lived this year. From moving back home to leaving the city, movement was a huge part of 2020. However, that could open you up to new tax regulations and additional tax bills due to state tax rates.
No matter where you work, you must file a state income tax return in your resident state. This tax return will report any and all income you earn. You may have to file a tax return in both states – where you live and where you work. This depends on if you live or work in one of the seventeen states with Reciprocal Agreements, which does not require two separate state tax returns. (This also applies if your employer is based in a different state than where you live.)
You must determine whether you were a
- Your main home is in that state for more than six months of the year.
- You do not live in that state but received income (you worked in the state).
- You temporarily worked in the state but did not move there permanently.
- Part-year resident
- You lived in the state during the tax year (different states have different requirements).
- You moved to a new state: you are a part-year resident of multiple states.
These distinctions will help with filing and determining how to file.
You may have moved during the year, which will require two different tax returns – one for each state. But, since you were a part-year resident in both states, you might be able to divide your income between both, instead of paying taxes twice.
If you have to submit more than one state tax return, you may be worried about having to pay duplicate taxes. However, you should be able to claim a tax credit on your resident tax return for taxes paid to states where you are not a resident.
Most Americans will be filing a federal income tax return and a state income tax return. But there are nine states in the U.S. that do not have state income tax:
- New Hampshire,
- South Dakota,
- and Wyoming.
If you are filing taxes having lived and worked in multiple states this year, it may be helpful to work with, and seek tax advice from, a tax professional.
COVID-19 Tax Changes
The COVID-19 pandemic led to tax code changes and funds for individuals and small businesses across the country. As we look at self-employed individuals filing taxes this year, there is the added question of the stimulus check, also known as the Economic Impact Payment, as well as sick and family leave credits.
Economic Impact Payment
Many Americans were sent stimulus checks this year, totaling $1,800 across two checks (one in April and one in December) for individuals. Individual taxpayers – and especially self-employed taxpayers – should keep Notice 1444 for their Economic Impact Payment with their 2020 tax records. This notice provides information about the payment and whether it was received. If you did receive your stimulus check, you do not owe taxes on it. The check is not considered taxable income by the IRS.
- you did not receive the Economic Impact Payment, or
- your payment was less than the eligible amount
Sick and Family Leave Credits
Under the Families First Coronavirus Response Act (FFCRA), eligible self-employed individuals can claim sick and family leave tax credits. The credit comes if you
- have been told to quarantine or self-isolate,
- are experiencing symptoms,
- are caring for someone who is quarantining or self-isolating,
- or are caring for a child whose school has closed or care provider is unavailable due to COVID-19.
The Act then designates three types of paid leave that pay for full sick leave, two-thirds rate sick leave, and two-thirds rate medical leave to care for a child.
Using Form 7202, you can determine your qualified sick and family leave equivalent tax credits. Those tax credits can be claimed on the 2020 Form 1040 “for leave taken between April 1, 2020, and December 31, 2020” and then on the 2021 Form 1040 “for leave taken between January 1, 2021, and March 31, 2021.”
There are some tax deductions to know about as a self-employed individual that can help minimize your taxable income and reduce your small business taxes and your self-employment taxes.
You can deduct the cost of office supplies and other materials you used to conduct business. Pen, paper, postage, and staples are eligible because you use them to run your business each day. Depending on when you bought them, you can also deduct computers and other electronic devices.
Credit card interest from business expenses is eligible to be deducted from your taxes along with your annual phone and internet bills.
Additionally, you may be eligible for Earned Income Tax Credit (EITC) Relief, which would allow you to reduce the taxes you owe and potentially increase your tax refund. This is for low- to moderate-income individuals. The IRS has an online tool to see if you qualify.
Another deduction, for income tax purposes, is allowed for the cost of health insurance. This deduction is taken into account when calculating net earnings and will be calculated with the Schedule SE.
Finally, your home-based business will also be eligible for tax benefits from the IRS, such as the home office tax deduction. If you are self-employed and working from home, you can use this deduction, and if you regularly (and exclusively) use a home office to conduct business, you can use this deduction.
This deduction allows you to write off items used for conducting business activities in your home like:
- Real estate taxes
The home office tax deduction is based on how much of your home is used for your own business. But if 10 percent of your house is your home office, then 10 percent of your home expenses (like those above) are deductible!
A lot of small business deductions are eligible for your single-person business too.
Things to Remember
As you get ready to file your taxes this year, there are two other things to remember as a self-employed individual or single-person business:
- You may have to work with a W-2,
- and you need to pay estimated tax quarterly.
Working with a W-2 as a self-employed individual typically comes if you were employed by a business as an employee. We covered most of that above, but one final point is differentiating expenses between W-2s and Schedule Cs. With the 2018 tax year, business expenses for wage or W-2 workers are no longer deductible on federal returns. So, you will need to itemize expenses for freelance or self-employed work on a Schedule C. This is not much different than how you note your self-employment income, but if you changed jobs this year it is important to keep in mind.
- Social Security and Medicare taxes,
- and income tax.
To determine if you are subject to these taxes, you need to see if your expenses are less than your income to create net income, according to Form 1040 or 1040-SR. Estimated tax is required because an employer is not withholding these taxes for you and is determined using Form 1040-ES and your prior year’s annual tax return. Generally, self-employed individuals “have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed” and if the tax owed was more than zero in the prior year. These quarterly payments can be made using The Electronic Federal Tax Payment System.
Filing This Year
Tax filing season has begun, and it is more important than ever before to ensure that you have your record-keeping in order and your tax situation checked to file properly. You should have copies of your business income ready for tax time and take note of new items – like the stimulus checks – that could impact your filing. It is always best to e-file to receive your tax refund or pay what you owe faster.
As always, it is essential to seek tax advice from a tax professional. These professionals can help with tax preparation and ensure that you are filing the correct tax forms and receiving the proper deductions and credits. Tax professionals can also ensure that you are making the proper payments to the IRS and reduce your tax liability.
This tax-filing piece is tailored to self-employed individuals, independent contractors, sole proprietors, and single-person businesses. We have published a recent piece on filing taxes as a small business.