What Is Financial Planning and Analysis (FP&A)?

Financial planning and analysis (FP&A) is the process businesses use to prepare budgets, generate forecasts, analyze profitability and otherwise inform senior management decisions of how to implement the company’s strategy most effectively and efficiently. The FP&A functions can be accomplished … Continue reading →

The post What Is Financial Planning and Analysis (FP&A)? appeared first on SmartAsset Blog.

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How to Start a WordPress Blog on Bluehost – Complete Guide

If you’re looking for a way to bring in some extra income and have a passion you’d enjoy sharing with others, blogging could be a great side gig or even potential full-time job for you. From travel to fashion, cooking to pilates, budgeting to home decor, it’s possible to blog about almost any topic, allowing you […]

How to Start a WordPress Blog on Bluehost – Complete Guide is a post from Money Crashers.

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What Is the Self-Employment Tax?

Working for yourself, either as a part-time side hustle or a full-time endeavor, can be very exciting and financially rewarding. But one downside to self-employment is that you're responsible for following special tax rules. Missing tax deadlines or paying the wrong amount can lead to expensive penalties.

Let's talk about what the self-employment or SE tax is and how it compares to payroll taxes for employees. You’ll learn who must pay the SE tax, how to pay it, and tips to stay compliant when you work for yourself.

What is the self-employment (SE) tax?

In addition to federal and applicable state income taxes, everyone must pay Social Security and Medicare taxes. These two social programs provide you with retirement benefits, disability benefits, survivor benefits, and Medicare health insurance benefits.

Many people don’t realize that when you’re a W-2 employee, your employer must pick up the tab for a portion of your taxes. Thanks to the Federal Insurance Contributions Act (FICA), employers are generally required to withhold Social Security and Medicare taxes from your paycheck and match the tax amounts you owe.

In other words, your employer pays half of your Social Security and Medicare taxes, and you pay the remaining half. Employees pay 100% of federal and state income taxes, which also get withheld from your wages and sent to the government.

When you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

But when you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

Who must pay the self-employment tax?

All business owners with "pass-through" income must pay the SE tax. That typically includes every business entity except C corporations (or LLCs that elect to get taxed as a corporation).

When you have a C corp or get taxed as a corporation, you work as an employee of your business. You're required to withhold all employment taxes (federal, state, Social Security, and Medicare) from your salary or wages. Other business entities allow income to pass directly to the owner(s), so it gets included in their personal tax returns.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

How much is the self-employment tax?

For 2020, the SE tax rate is 15.3% of earnings from your business. That's a combined Social Security tax rate of 12.4 % and a Medicare tax rate of 2.9%.

For Social Security tax, you pay it on up to a maximum wage base of $137,700. You don't have to pay Social Security tax on any additional income above this threshold. However, this threshold has been increasing and is likely to continue creeping up in future years.

However, for Medicare, there is no wage base. All your income is subject to the 2.9% Medicare tax.

So, if you're self-employed with net income less than $137,700, you'd pay SE tax of 15.3% (12.4% Social Security plus 2.9% Medicare tax), plus ordinary income tax.

Remember that your future Social Security benefits get reduced if you don't claim all of your self-employment income.

What is the additional Medicare tax?

If you have a high income, you must pay an extra tax of 0.9%, known as the additional Medicare tax. This surtax went into effect in 2013 with the passage of the Affordable Care Act (ACA). It applies to wages and self-employment income over these amounts by tax filing status for 2020:

  • Single: $200,000 
  • Married filing jointly: $250,000 
  • Married filing separately: $125,000 
  • Head of household: $200,000 
  • Qualifying widow(er): $200,000

What are estimated taxes?

As I mentioned, when you’re an employee, your employer withholds money for various taxes from your paychecks and sends it to the government on your behalf. This pay-as-you-go system was created to make sure you pay all taxes owed by the end of the year.

You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

When you’re self-employed, you also have to keep up with taxes throughout the year. You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

Each payment should be one-fourth of the total you expect to owe. Estimated payments are generally due on:

  • April 15 (for the first quarter) 
  • June 15 (for the second quarter) 
  • September 15 (for the third quarter) 
  • January 15 (for the fourth quarter) of the following year

But when the due date falls on a weekend or holiday, it shifts to the next business day. Your state may also require estimated tax payments and may have different deadlines.

How to calculate estimated taxes

Figuring estimated payments can be extremely confusing when you’re self-employed because many entrepreneurs don’t have the faintest idea how much they’ll make from one week to the next, much less how much tax they can expect to pay. Nonetheless, you must make your best guesstimate.

If you earn more than you estimated, you can pay more on any remaining quarterly tax payments. If you earn less, you can reduce them or apply any overpayments to next year’s estimated payments.

If you (or your spouse, if you file taxes jointly) have a W-2 job in addition to self-employment income, you can increase your tax withholding from earnings at your job instead of making estimated payments. To do this, you or your spouse must file an updated Form W-4 with your employer.

The IRS has a Tax Withholding Estimator to help you calculate the right amount to withhold from your pay for your individual or joint taxes.

How to pay estimated taxes

To figure and pay your estimated taxes, use Form 1040-ES, Estimated Tax for Individuals, or Form 1120-W, Estimated Tax for Corporations. These forms contain blank vouchers you can use to mail in your payments, or you can submit funds electronically.

When you have a complicated situation, including having business income, one of your new best friends should be a tax accountant.

For much more information about running a small business successfully, check out my newest book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. Part four, Understanding Business Taxes, covers everything you need to know to comply and stay out of trouble.

From personal experience, I can tell you that when you have a complicated situation, including having business income, one of your new best friends should be a tax accountant. Find one who listens well and seems to understand the kind of work you're doing.

A good accountant will help you calculate your estimated quarterly taxes, claim tax deductions, and save you money by helping you take advantage of every tax benefit that's allowed when you're self-employed. In Money-Smart Solopreneur, I recommend various software, online services, and apps to help you track expenses, deductions, and tax deadlines that will keep your business running smoothly.

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5 Things to Know About the Home Office Tax Deduction and Coronavirus

Since the coronavirus quarantine began, many people have been forced to work from home. If you didn’t have a home office before the pandemic, you might have had a few expenses to set one up. I’ve received several questions about what benefits are allowed for home offices during the COVID-19 crisis.

One question came in on the QDT coronavirus question page. Money Girl reader Ian said:

"I have a question about next year's taxes and working from home. For the past 13 weeks, I have been forced to work from a home office. (I am a regular W-2 employee, not self-employed.) I have had some expenses come up that were brought about by working from home: a computer upgrade so I can better connect to Wi-Fi, a new router, and even a desk chair so I am comfortable while I work. Should I be keeping track of those expenses? Will they be deductible? My employer is not going to reimburse them. Thank you for your help!"

Another question came from Miki, who used my contact page at Lauradadams.com to reach me. She said:

"Hi, Laura, and thank you for a wonderful podcast! I've been listening for years and have always thought that you'd have a show for any question I could ever think of. But this new situation with COVID-19 has made me think of something that I'm sure many of us are dealing with right now.

"To start working from home, I had to spend quite a bit of money to get my home office on par with my actual office. I know you've done episodes on claiming home office expenses on taxes before, but could you do an episode on whether we can claim home office expenses on our taxes next year? And if we can, things we should start thinking about now (aside from saving the receipts)?"

Thanks for your kind words and thoughtful questions! I'll explain who qualifies for a home office tax deduction and serve up some tips for claiming it.

5 things to know about the home office tax deduction during coronavirus

Here's the detail on five things you should know about qualifying for the home office tax deduction in 2020.

1. COVID-19 has not changed the home office tax law

The CARES Act changed many personal finance rules—including specific tax deadlines, retirement distributions, and federal student loan payments—but the home office tax deduction is not one of them. In a previous post and podcast, Your Guide to Claiming a Legit Home Office Tax Deduction, I covered the fact that the Tax Cuts and Jobs Act (TCJA) of 2017 drastically changed who can claim this valuable deduction.

Before the TCJA, you could claim a home office deduction whether you worked for yourself or for an employer either full- or part-time. Unfortunately, W-2 employees can no longer take advantage of this tax benefit. Now, you must have self-employment income to qualify. My guess is that the IRS was concerned that it was too easy to abuse this benefit and reined it in.

Before the TCJA, you could claim a home office deduction whether you worked for yourself or for an employer either full- or part-time. Unfortunately, W-2 employees can no longer take advantage of this tax benefit.

The best option for an employee is to request expense reimbursement from your current or future employer even though they're not obligated to pay you. If you get pushback, make a list of all your home office expenses so it's clear how much you spent on their behalf. They might consider it for your next cost of living raise or bonus.

Unless Miki or Ian have a side business that they started or will start, before the end of 2020, they won't get deductions to help offset their home office setup costs.

 

2. The self-employed can claim a home office tax deduction

Let’s say you use a space in a home that you rent or own for business purposes in 2020. There are two pretty straightforward qualifications to qualify for the home office deduction:

  • Your home office space must be used regularly and exclusively for business
  • Your home office must be the principal place used for business

You could use a spare bedroom or a hallway nook to run your business. You don’t need walls to separate your office, but the space should be distinct—unless you qualify for an exemption, such as running a daycare. It’s permissible to use a separate structure, such as a garage or studio, as your home office if you use it regularly for business.

You must use your home as the primary place you conduct business—even if it’s just for administrative work, such as scheduling and bookkeeping. However, your home doesn’t have to be the only place you work in. For instance, you might work at a coffee shop or meet clients there from time to time and still be eligible for a home office tax deduction.

3. Your business can be full- or part-time to qualify for a home office tax deduction

If you work for yourself in any trade or business, either full- or part-time, and your primary office location is your home, you have a home business. No matter what you call yourself or your business, if you have self-employment income and do any portion of the work at home, you probably have an eligible home office. You might sell goods and services as a small business, freelancer, consultant, independent contractor, or gig worker.

If you work for yourself in any trade or business, either full- or part-time, and your primary office location is your home, you have a home business.

As I previously mentioned, the work you do at home could just be administrative tasks for your business, such as communication, scheduling, invoicing, and recordkeeping. Many types of solopreneurs and trades do most of their work away from home and still qualify for a legitimate home office deduction. These may include gig economy workers, sales reps, and those in the construction industry.

4. You can deduct direct home office expenses for your business

If you run a business from home, your direct home office expenses qualify for a tax deduction. These are costs to set up and maintain your office, such as furnishings, installing a phone line, or painting the walls. These costs are 100% deductible, no matter the size of the office.  

5. You can deduct indirect home office expenses for your business

Additionally, you’ll have costs that are related to your office that affect your entire home. For instance, if you’re a renter, the cost of rent, renters insurance, and utilities are examples of indirect expenses. You’d have these expenses even if you didn’t have a home office.

If you own your home, potential indirect expenses typically include mortgage interest, property taxes, home insurance, utilities, and maintenance. You can't deduct the principal portion of your mortgage payment, which is the amount borrowed for the home. Instead, you’re allowed to recover a part of the cost each year through depreciation deductions, using formulas created by the IRS.

Allowable indirect expenses actually turn some of your personal costs into home office business deductions, which is fantastic! They’re partially deductible based on the size of your office as a percentage of your home—unless you use a simplified calculation, which I’ll cover next.

How to calculate your home office tax deduction

If you qualify for the home office deduction, there are two ways you can calculate it: the standard method or the simplified method.

The standard method requires you to keep good records and calculate the percentage of your home used for business. For example, if your home office is 12 feet by 10 feet, that’s 120 square feet. If your entire home is 1,200 square feet, then diving 120 by 1,200 gives you a home office space that’s 10% of your home.

In this example, 10% of your qualifying expenses could be attributed to business use, and the remaining 90% would be for personal use. If your monthly power bill is $100 and 10% of your home qualifies for business use, you can consider $10 of the bill a business expense.

To claim the standard deduction, use Form 8829, Expenses for Business Use of Your Home, to figure out the expenses you can deduct and then file it with Schedule C, Profit or Loss From Business.

The simplified method doesn’t require you to keep any records, which makes it incredibly easy to claim. You can claim $5 per square foot of your office area, up to a maximum of 300 square feet. So, that caps your deduction at $1,500 (300 square feet x $5) per year.

The simplified method requires you to measure your office space and include it on Schedule C. It works best for small home offices, while the standard approach is better when your office is bigger than 300 square feet. You can choose the method that gives you the largest tax break for any year.

No matter which method you choose to calculate a home office tax deduction, you can't deduct more than your business's net profit. However, you can carry them forward into future tax years.

Also note that business expenses that are unrelated to your home office—such as marketing, equipment, software, office supplies, and business insurance—are fully deductible no matter where you run your business.

If you have any questions about qualifying business expenses, home office expenses, or taxes, consult with a qualified tax accountant to maximize every possible deduction and save money. The cost of working with a trusted financial advisor or tax pro is worth every penny.

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