Saturday, March 26, 2011

Self-Employment Income this year? Here's how to report it.

Schedule C is the form to use when reporting Self-Employment and business income.

All income pertaining to the business is reported. Expenses are subtracted from income to determine if there is a gain (profit) or loss. The net profit or loss is entered on line 12 of Form 1040. If a taxpayer owns and operates more than one business activity, file a separate Schedule C for each business. Combine the profits and losses on Form 1040 line 12 if there is more than one Schedule C.

If net earnings from self-employment are $400 or more, the taxpayer must file an income tax return. If net earnings from are less than $400, the taxpayer may still have to file a return and would still report the net earnings.

Independent contractors are also considered self-employed for federal tax purposes and are required to file Schedule C. Many contractors incorrectly report these amounts as wages or as other income. A taxpayer who feels he or she was misclassified as a contractor can request a determination letter.

An independent contractor being paid more than $600 or more from one company should be issued a Form 1099-MISC.

If net earnings from all combined Schedules C are $400 or more, the taxpayer must file a tax return and also Schedule SE to pay self-employment tax (social security and Medicare taxes). It's similar to the FICA taxes that are withheld from the pay of an employee. The difference is a self-employed taxpayer pays both parts of the social security (12.4%) and Medicare (2.9%) taxes for a total of 15.3%.

Since there is generally no withholding for a self-employed taxpayer, he or she should estimate income and taxes for each quarter and send quarterly payments to the IRS.

Taxpayer must be able to substantiate their self-employment income. The IRS will disallow an unjustified claim for the earned income credit who report self-employment income but doesn't have any.

Any taxpayer who is filing a Schedule C must claim any expenses that were incurred. Thus, it is critical to keep track of income and expenses to prove your business is legit.

Some suggestions include:
  • Maintaining a separate bank account for the business
  • registering the business
  • obtaining a business license from a government agency
  • creating business cards and writing a business plan
  • advertise in the yellow pages
  • apply for an Employer Identification Number using Form SS-4
  • hire an accountant to prepare your bookkeeping
On the other hand, an activity is considered a for-profit business if the net earnings are greater than zero for any three of the most recent five years. If the IRS determines a business is not engaged for profit, the deductions will be disallowed.

You may be able to deduct business expenses for your home, including part of your mortgage interest, insurance, utilities, repairs, business furniture, and depreciation. You can also deduct expenses from using your personal vehicle for business.

Check with IRS Publication 587 to make sure you're in compliance. For a tax guide for small business owners, review IRS Publication 334.

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