U.S. Self Employment Income

by L. Kenway BComm CPB


Self-employment income means you need to become familiar with IRS tax compliance requirements ... to avoid getting into deep dodo.

Sole proprietors must pay self-employment tax on their net earnings. Here is basic information you need to get you started on the right foot.

Bookkeeping-Deadline Reminders

Chat 1

Small Business Deadlines

Interest Rates and More

Estimated Tax Payments For The Self Employed

This Chat

Self Employment Income

Standard Mileage Rates

IRS Independent Contractor

Chat 3

Independent Contractors
Rules/Checklist




Information About Your Self Employment Income You Need To Know
The Doctrine of Constructive Receipt

Are You Permitted to Receive / Write Postdated or Predated Cheques?


Small Business Owners are 940 percent more likely to get audited!
Click on the Tax Receipts image above to learn more.

When accounting for self employment income, it is important to understand the constructive receipt principle.

Under the doctrine of constructive receipts, cash basis taxpayers (as opposed to accrual basis taxpayers) are not permitted to receive/write postdated or predated cheques.

The doctrine of constructive receipts is defined in the regulations but was conceived by the courts to test realization of income. It prevents a cash basis taxpayer from selecting the year in which income will be reported. Its purpose is to prevent tax avoidance.

For tax purposes, a cheque is constructively received when it is delivered to the taxpayer ... not when it is cashed.

Source: Barriers to the application of the constructive receipt doctrine by Knight, Lee, G, Knight, Ray A. published in Tax Executive on January 1, 1989



                               good bookkeeping practice
THE BOOKKEEPER'S|TIP    

Employment Identification Number

Sole proprietors should apply for an employment identification number.

Earning self employment income means that come January each year, you will begin receiving your 1099MISC forms in the mail or by eMail. With identity theft on the rise, here is something you should put on your to-do list.

This tip comes from TaxReceipts.com. A great site to visit. They talk tax in plain English.

"Consider obtaining an Employer Identification Number from the IRS for your business, even if you are a sole proprietor. The last thing you want is to send your Social Security Number to every company that you do work for and to have your SSN plastered across the front of every 1099-MISC form that is sent to you in January."



GOOD TO KNOW

Which Business Entity Is Best For You?

Handy bookkeeping reference

Sole Proprietors' self employment income (net earnings) are subject to self employment tax and must make quarterly estimated tax payments. You are NOT an employee which means you take a draw. Incorporating doesn't make sense for everyone, especially if the corporation will be under capitalized.

S-Corp distributions to shareholders (not to be confused with payroll earnings) are NOT subject to self employment tax. However all owners must be on the payroll and receive a reasonable amount of compensation which is subject to payroll taxes. It should be your main source of income. You are only allowed to take losses up to your basis. Negative basis is treated is a non-deductible loss.

The IRS audits this corporate structure to ensure working shareholders are not trying to minimize payroll tax by paying too low a salary.

Want to get audited? Don't pay yourself any compensation!

You may want to read the October 1, 2013 article Current Developments in S Corporations by The Tax Adviser for recent changes / developments.

C-Corp shareholders must be a working employee to receive compensation that is restricted to a reasonable amount. The corporation pays half of the payroll taxes. Double taxation may occur if dividends are issued.

Reasonable amount is defined as an amount you would pay an arm's length person for doing the same job.

Estimated Tax Payments On Your Self Employment Income
Due Dates For 2013/2014

This is the method used to pay income taxes on income not subject to withholding taxes ... i.e. your self employment income.

You need to pay estimated taxes four times if your tax is $1,000 or more after subtracting withholdings and credits ... AND you expect your withholdings and credits to be less than 90% of your 2013 taxes paid OR 100% of your 2012 taxes paid. You may be charged a penalty if you don't pay enough tax by each due date. If you like smoothing out your cash flow over the year, you can setup monthly payments on EFTPS instead of the four required payments.

Tax Type Tax Period Form to be Filed Filing AND Payment Deadline Week Day
Annual Est. Payment Farmers, Fishermen20131040-ESJanuary 15, 2014 Wednesday
1st Tax Installment
(3 months)
Jan-Mar 20141040-ES
pay thru EFTPS
April 15, 2014Tuesday
2nd Tax Installment
(2 months)
Apr-May 20141040-ES
pay thru EFTPS
June 16, 2014Monday
3rd Tax Installment
(3 months)
Jun-Aug 20141040-ES
pay thru EFTPS
September 15, 2014Monday
4th Tax Installment
(4 months)
Sep-Dec 20141040-ES
pay thru EFTPS
January 15, 2015* Thursday


*You don't need to pay the January 15 estimated tax payment if you file your 2014 tax return with taxes due by January 31, 2015. However, if you do need to make a payment, best practice is review your estimated earnings and payments made to date. Adjust your fourth payment to ensure you aren't under paying or over paying your tax. IF you choose to write a cheque rather pay online through EFTPS ... although why you would choose this payment method is beyond me ... the cheque is made payable to United States Treasury.

BOOKKEEPER'S HANDY
REF
ERENCE

Barbara Weltman, attorney and author, wrote an excellent article for SBA.gov titled "5 Traps in Paying Estimated Taxes".

Read her blog to find out more about these five traps:

  1. Failing to have cash on hand.
  2. Not covering all tax obligations.
  3. Believing each quarterly payment falls evenly.
  4. Paying too much, too early.
  5. Reporting the payment under the SSN of the wrong spouse.


See the IRS Estimated Taxes Guide for more small business information on estimated taxes located on their website by entering "Estimated Taxes" into the search box. It is a lot easier than trying to find things on their new site ... you sometimes have to go 4 to 6 levels deep to get what you want now!

Under their new site ... it is much harder to find information. IRS> Filing> Self Employed and Small Businesses> Employment Taxes> Self Employed (on left hand side navigation bar)> How Do I Make My Quarterly Payments?> find the inline text link for "Estimated Taxes" in the last paragraph.

You used to get there is three clicks ... Businesses> Self-Employed> If you are self-employed you must pay Estimated Taxes. Now it is six clicks!

There is also a good small business tax information article on How Much to Pay at fairmark.com/estimate/howmuch.htm. It explains how to decide what is the best way for you to calculate your estimated taxes.



Self Employment Tax / FICA

Self employment income is subject to FICA/SICA. What is the FICA tax rate for a self employed individual?

Well this is embarrassing! "Someone" (that would be me!) moved the data to a whole new page all it's own.

As you need to know this stuff,  you'll find FICA rates for your self employment income here.



2014 Standard Mileage Rates

Source: IR 2012 95 (IR 2011 116; IR-2010-119); N-2013-80 (N-2012-72 N-2012-01 A-2011-40)

Normally released late November or early December each year; updated December 6, 2013

Earning self employment income often requires business travel. Here are the mileage rates allowed by IRS.

2014 Cents/Mile 2013 Cents/Mile Rate Type 2012 Cents/Mile 2011 Cents/Mile
56.056.5Business Miles Driven*55.551.0 1st 6 months
55.5 last 6 months
23.524.0Moving / Relocation Purposes23.019.0 1st 6 months
23.5 last 6 months
23.524.0Medical Purposes23.019.0 1st 6 months
23.5 last 6 months
14.014.0Charitable Services Rate14.014.0

THE BOOKKEEPER'S TIP

AIPB's newsletter dated February 24, 2014 explains that "a portion of the standard mileage deduction must be used to reduce a vehicle’s basis, as follows: 22¢/mi.for 2014, 23¢/mi. for 2013, 23¢/mi. for 2012, 22¢/mi. for 2011 and 23¢/mi. for 2010. [Notice 2013-80; 2013-52 IRB 821; IR-2013-95]"

*You cannot use the business standard mileage rate :

  • for any vehicle used for hire or for more than four vehicles used simultaneously;
  • for a vehicle after claiming a Section 179 deduction for that vehicle; or
  • after using any depreciation method under the Modified Accelerated Cost Recovery System (MACRS).

Vehicle means any car, van, pickup or panel truck. You always have the option of calculating the actual costs of using your vehicle rather than using the standard mileage rates.

You do need a mileage log to support the number of miles your vehicle was driven for business purposes.

While you can't deduct actual vehicle operating costs (fixed and variable) under this method, you are allowed to deduct parking and toll expenses related to business, the business portion of interest paid on vehicle loans, and the business portion of any local or state personal property tax paid on the vehicle. (See IRS Revenue Procedure 2010-51 Section 4.03.)

Historical mileage rates can be found of on the IRS website at irs.gov> Tax Professionals> Standard Mileage Rates . If the page can't be found when you key it into your browser, do a search on the IRS website for "standard mileage rates". Choose the article titled Standard Mileage Rates ... following table summarizes ...

The standard mileage rates are based on an annual study by independent contractor Runzheimer International. The study based the business rate on the fixed and variable costs of operating a vehicle while medical and moving are based on the variable costs.

Additional small business tax information on using the standard mileage rate can be found in IRS Publication 463 Travel, Entertainment, Gift, and Car Expenses.


Entertainment - What's Deductible, What's Not

Part of earning self employment income necessitates entertaining potential and existing customers and clients. Section 274 of the tax code deals with the disallowance of certain entertainment, amusement or recreation expenses.

If you have a business meal at a club facility:

  1. You CANNOT deduct any facility fees or dues.
  2. You must establish that the activity was associated and conducted for purposes relating to your business. The business discussion could occur directly before or after the activity.
  3. The business expense must be ordinary, necessary, and paid or incurred during the tax year to produce or collect income.

This section generally includes expenses relating to meals, travel and vehicle. Visit law.cornell.edu> US code> Title 26> Subtitle A> Chapter 1> Subchapter B> Part IX> Section 274 and Part VII> Section 212 for more details.

Section 162 states you must PROVE the expense is ordinary AND necessary to doing your business. You also have to provide proof the business expense has been paid.

No one said earning self employment income would be easy. This is a frequently audited area so know the rules.




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