Self Employed Federal Tax

[jaladhijoshi]

Hi,

I am a full time worker (on company W2) and my wife is  self-employed. I have some questions around tax return filing and optimizing tax benefits:

1. Is it more beneficial if we file our taxes separately or file jointly? For around $12,000 self employed income?

2. Quarterly Tax prepayments: In 2021, we have not done quarterly tax prepays, as we did not know about it. How much penalty are applicable, if the income is about 12,000 for the year.

3. What all taxes are applicable on Self-employed income? For example, do we pay for both the employer and employee Social Security Tax and Medicare? Is 15% tax bracket is a good guess for federal tax? Any other taxes that are applicable for self employed personal?

4. What other qualifying expanses that we can deduct so as to reduce taxable income? The idea of filing separately was to use standard deduction on income to reduce income tax. Is it a valid assumption?

[ronaldg11]

Hi Jaladhijoshi,

1. Is it more beneficial if we file our taxes separately or file jointly? For around $12,000 self employed income?

Usually married filing jointly is the better filing status but tools like TurboTax's TaxCaster can help you decide which status is best for you by simulating various tax scenarios.  You can find TaxCaster at:   https://turbotax.intuit.com/tax-tools/calculators/taxcaster/

2. Quarterly Tax prepayments: In 2021, we have not done quarterly tax prepays, as we did not know about it. How much penalty are applicable, if the income is about 12,000 for the year.

The IRS calculates this penalty by figuring out how much you should have paid each quarter and multiplying the difference between what you paid and what you should have paid by the effective interest rate for that period. This means you can have a penalty for one quarter, but not the others.  If you owe more than $1,000 when you calculate your taxes, you could be subject to a penalty. To avoid this you should make payments throughout the year via tax withholding from your paycheck or estimated quarterly payments, or both.

https://turbotax.intuit.com/tax-tips/irs-letters-and-notices/guide-to-irs-tax-penalties-how-to-avoid...

3. What all taxes are applicable on Self-employed income? For example, do we pay for both the employer and employee Social Security Tax and Medicare? Is 15% tax bracket is a good guess for federal tax? Any other taxes that are applicable for self employed personal?

Self-employed people are responsible for paying the same federal income taxes as everyone else.  In addition to income taxes, everyone must pay Social Security and Medicare taxes. If you are self-employed you need to make these tax payments yourself since you don’t have an employer to send it in for you.

https://turbotax.intuit.com/tax-tips/self-employment-taxes/self-employed-federal-income-taxes/L7fmfV...

4. What other qualifying expanses that we can deduct so as to reduce taxable income? The idea of filing separately was to use standard deduction on income to reduce income tax. Is it a valid assumption?

 You can write off a wide variety of business expenses you paid during the year, including things like:

• Advertising costs
• Commissions
• Supplies
• Legal fees
• Repairs and maintenance
• office expenses 
• For more see:

https://turbotax.intuit.com/tax-tips/self-employment-taxes/reporting-self-employment-business-income...

Hope this helps

Ron G

[ReneeTAXEA1 · Accepted solution]

Thank you for contacting TurboTax Live!  We see that you had a question - about your spouse's self-employment during the 2021 tax year, and the fact that you are a full time worker (with a W-2 provided by your employer for the tax year).

We see you had several questions about your filing status (whether to file jointly as MFJ, or whether to file as separate as MFS), as well as the question concerning quarterly estimated taxes, that you did not appear to pay during the 2021 tax year!

We thank you for your questions! We also thank you for the opportunity to respond to your questions!

We will take your questions one by one, and hope that this is OK with you and your spouse!!  Congrats to your spouse on achieving self-employment in the 2021 tax year.  That is incredible news, and we hope this gives you and your family the sense of independence that the self-employed business owners are sometimes able to enjoy!!!

With regard to your questions regarding tax return filing status and optimizing tax benefits, here are some options and suggestions based on your specific questions (as below):

1. Is it more beneficial if we file our taxes separately or file jointly?  And - for what you approximated to be around $12,000.00 of self employed income?

Answer:  Married couples have the option to file jointly or separately on their federal income tax returns.  The IRS strongly encourages most couples to file joint tax returns by extending several tax breaks to those who file together.  In the vast majority of cases, it's best for married couples to file jointly, but there may be a few instances when it's better to submit separate returns.

Advantages of filing jointly

There are many advantages to filing a joint tax return with your spouse. The IRS gives joint filers one of the largest standard deductions each year, allowing them to deduct a significant amount of their income immediately.

Couples who file together can usually qualify for multiple tax credits such as the:

• Earned Income Tax Credit
• American Opportunity and Lifetime Learning Education Tax Credits
• Exclusion or credit for adoption expenses
• Child and Dependent Care Tax Credit

Joint filers mostly receive higher income thresholds for certain taxes and deductions—this means they can earn a larger amount of income and potentially qualify for certain tax breaks.

Consequences of filing your tax returns separately

On the other hand, couples who file separately receive few tax considerations. Separate tax returns may give you a higher tax with a higher tax rate. The standard deduction for separate filers is far lower than that offered to joint filers.

• In 2021, married filing separately taxpayers only receive a standard deduction of $12,500 compared to the $25,100 offered to those who filed jointly.
• If you file a separate return from your spouse, you are automatically disqualified from several of the tax deductions and credits mentioned earlier.
• In addition, separate filers are usually limited to a smaller IRA contribution deduction.
• They also cannot take the deduction for student loan interest.
• The capital loss deduction limit is $1,500 each when filing separately, instead of $3,000 on a joint return.

When you might file separately

In rare situations, filing separately may help you save on your tax return.

• For example, if you or your spouse has a large amount of out-of-pocket medical expenses to claim and since the IRS only allows you to deduct the amount of these costs that exceeds 7.5% of your adjusted gross income (AGI) in 2021, it can be difficult to claim most of your expenses if you and your spouse have a high AGI.
  • For example, if you have $10,000 in medical expenses and made $50,000. That would meet the 7.5% threshold ($10,000 ÷ $50,000 = 20% of your income).
  • Whereas, if together you make $135,000, this would disqualify you from claiming these medical expenses ($10,000 ÷ $135,000 = 7.4% of your income).
• Filing separate returns in such a situation may be beneficial if it allows you to claim more of your available medical deductions by applying the threshold to only one of your incomes.

For more tips on when you might want to file separately, be sure to check out our article When Married Filing Separately Will Save You Taxes.

Deciding which status to use

The best way to find out if you should file jointly or separately with your spouse is to prepare the tax return both ways. Double check your calculations and then look at the net refund or balance due from each method. If you use TurboTax to prepare your return, we’ll do the calculation for you, and recommend the filing status that gives you the biggest tax savings.

2. Quarterly Tax prepayments: In 2021, we have not done quarterly tax prepayments, as we did not know about it. How much penalty are applicable, if the income is about $12,000.00 for the 2021 tax year.

Answer:  If you are an employee, your employer withholds income taxes from each paycheck based on a completed W-4 Form.  Usually, that's enough to take care of your income tax obligations.  But if you are self-employed or make money on your investments or rental property, you may need to make estimated tax payments every quarter, rather than wait until you file your annual tax return.

Here's how estimated taxes work:

In most cases, to avoid a penalty, you need to make estimated tax payments if you expect to owe $1,000.00 or more in taxes for the year—over and above the amount withheld from your wages. In some cases, though, the $1,000.00 trigger point doesn't matter.  (Note:  Since we do not know your anticipated compensation - in the form of salary/wages for your full-time employment during 2021, we did not want to speculate - so we put the full tax rules - based on your anticipated AGI - as below):

• If your prior year Adjusted Gross Income was $150,000 or less, then you can avoid a penalty - if you pay either 90 percent of this year's (meaning 2021 tax year) income tax liability or 100 percent of your income tax liability from last year (meaning 2020 tax year) - dividing what you paid last year (the total tax liability for 2020) - into four (4) quarterly payments.  This rule helps if you have a big spike in income one year, say, because you sell an investment for a huge gain or win the lottery. If wage withholding for the year equals the amount of tax you owed in the previous year, then you wouldn't need to pay estimated taxes, no matter how much extra tax you owe on your windfall.
• If your prior year's Adjusted Gross Income (for the 2020 tax year) was greater than $150,000, then you must pay either 90 percent of this year's income tax liability or 110 percent of last year's income tax liability.

3. What all taxes are applicable on Self-Employed income?  For example, do we pay for both the employer and employee Social Security Tax and Medicare? Is 15% tax bracket is a good guess for federal tax? Any other taxes that are applicable for self employed personal?

Answer:  Many newly self-employed people — sole proprietors, independent contractors and the like — are surprised at their tax bills at the end of the year, because they notice they're suddenly paying a lot more in tax as a self-employed person than as an employee. That's because they're carrying the full burden of paying for their Social Security and Medicare.

When you're an employee, you share that cost with your employer, with each of you paying a share of the FICA tax. When you're self-employed, though, you're stuck with the full full amount yourself.

The self-employment tax is divided into two parts:

• 12.4% for Social Security. For 2021, this part of the tax applies to the first $142,800 of earnings. If you earn more than that (from self-employment or, if you also have a job, from the combination of your job and your business), then the 12.4 percent part of the tax that pays for Social Security stops for the year.
• 2.9% for Medicare. The Medicare portion of the self-employment tax doesn’t stop. No matter how much you earn, you'll pay the 2.9 percent Medicare tax. For more information on this tax, see IRS Tax Topic 554: The Self-Employment Tax.

How do I report the self-employment tax?

Of course, a new tax means new paperwork too. When you start a small business and you do not incorporate or form a partnership, you report the results of your operations on Schedule C and file it with your Form 1040.

You calculate your self-employment tax on Schedule SE and report that amount in the "Other Taxes" section of Form 1040. In this way, the IRS differentiates the SE tax from the income tax.

The Silver Lining - there is "Some Good News" . . . . 

When figuring self-employment tax you owe, you get to reduce self-employment income by half of the self-employment tax before applying the tax rate. Say, for example, that your net self-employment income is $50,000. That's the amount you report as taxable for income tax purposes on Form 1040.

But when figuring your self-employment tax on Schedule SE, Computation of Social Security Self-Employment Tax, the taxable amount is $46,175. Not paying the 15.3 percent tax on $3,825 difference in this example saves you $585.

And - there's more good news . . . . 

You can claim 50% of what you pay in self-employment tax as an income tax deduction. For example, a $1,000 self-employment tax payment reduces taxable income by $500. In the 25 percent tax bracket, that saves you $125 in income taxes. This deduction is an adjustment to income claimed on Form 1040, and is available whether or not you itemize deductions.

Here's an example of how the self-employed taxes are calculated:

• You run a catering business as a sole proprietor.
• In 2021 - your net profit as reported on Schedule C is $35,000.00.
• Your net earnings as calculated on Form SE would be $32,323.00 ($35,000.00 x 0.9235).
• Your self-employment tax would be $4,945.00 ($32,323.00 x 0.153) and you would report that amount on Form 1040 in the "Other Taxes" section.

Then you would report one-half of your self-employment tax, $2,473.00 ($4,945.00 X 0.50) on Form 1040 as an adjustment to income, which reduces your Adjusted Gross Income and the amount of income tax you owe.

Should I file estimated taxes?

If you have worked as an employee, you know that what you get in your paycheck is usually less than what you really made. Why? Because your employer withheld money for Social Security, Medicare and income tax and sent that money to the government.

When you are self-employed, the entire burden for paying employment taxes and prepaying estimated income tax liability is left to you. The government wants you to make payments of your estimated taxes throughout the year in quarterly installments. If you don't, you may be subject to underpayment penalties.

• If you're not sure whether you meet the definition of being self-employed, see IRS Tax Topic 554: The Self-Employment Tax.
• For more information on estimated taxes, see this IRS article on Estimated Taxes.

Don’t worry about knowing which tax forms to fill out when you are self-employed, TurboTax Self-Employed will ask you simple questions about you and your business and give you the business deductions you deserve based on your answers. TurboTax Self-Employed uncovers industry-specific deductions. Some you may not even be aware of.

4. What other qualifying expenses that we can deduct so as to reduce taxable income? The idea of filing separately was to use standard deduction on income to reduce income tax. Is it a valid assumption?

Answer:  No, in terms of filing as married filing separately (MFS) as opposed to married filing jointly (MFJ), this will not cause you to realize your goal of using the standard deduction on each filing (assuming there was one MFS for you, and a companion MFS filing for your spouse).

Self-employed taxpayers report their business income and expenses on Schedule C.   Since your question (as posted) did not specify if the $12,000.00 of business income was gross income or net income, then we are unsure if this estimate of the 2021 tax year self-employed business income - took into account the business expenses as your spouse may have incurred during the 2021 tax year.

We are going to discuss the Schedule C - Business Income & Expenses - in detail, as is explained below:

TurboTax Live!  can help make the job easier.

Schedule C: Consider income, expenses and vehicle information

Each year, sole proprietors (and folks engaged in self-employment) have the chore of preparing and filing Schedule C with their 1040.  The Schedule C - is used to state the taxpayer's self-employment income and related and qualified business expenses - to show the IRS whether the self-employed business had a taxable profit or a deductible loss for the 2021 tax year.

Schedule C can seem daunting, and does require recordkeeping on the part of you and your spouse - but preparing and filing your tax returns will be significantly easier . . . .  if you plan ahead and keep good records, especially if those good records are substantiated by proper business records and documentation.

We've broken down the Schedule C into a few sections (as appear below), so you can see what the IRS expects from you and your spouse . . . . . and what records you may need at tax time.

Part I: Income

In this section, you calculate your gross income.

Start by reporting gross receipts or sales for the year, including amounts reported on 1099 forms that  were issued by clients or others for whom you provided services.

Other types of income you must report include:

• The value of goods or services you received through barter transactions
• Bad debts you recovered if they were written off on prior-year tax returns
• Interest on business bank accounts.

Total up these items and subtract your cost of goods sold (which is calculated in Part III and explained below) to arrive at gross income.

Part II: Expenses

This is where good record keeping can really save you money on your taxes. You can write off a wide variety of business expenses you paid during the year, including things like:

• Advertising costs
• Commissions
• Supplies
• Legal fees
• Repairs and maintenance
• office expenses

You can also deduct:

1. Car and truck expenses: You can report these costs in one of two ways: Enter your actual expenses—for gas, oil changes, repairs, insurance, etc.—if you have supporting documentation, or take the IRS standard mileage rate. The rate for 2021 is 56 cents per mile.

2. Depreciation and Section 179 expense deduction: The law allows businesses to depreciate—or gradually deduct the cost of —assets such as equipment, fixtures, furniture, etc., that will last more than one year. For these assets, you first fill out Form 4562: Depreciation and Amortization, and enter the result on Schedule C.

You also use Form 4562 if you elect the Section 179 "expensing" deduction. Section 179 lets you deduct the full cost of assets (both new and used) in the year they are placed in service, subject to certain limits.

3. Bonus Depreciation: Bonus depreciation has been changed for qualified assets acquired and placed in service after September 27, 2017.  For qualified assets that were purchased new before September 28, 2017, the old rules of 50% bonus depreciation still apply. The new rules allow for 100% bonus "expensing" of assets that are new or used.

The percentage of bonus depreciation phases down in the year:

• 2023 to 80%
• 2024 to 60%
• 2025 to 40%
• 2026 to 20%.

After 2026 there is no further bonus depreciation. This bonus "expensing" should not be confused with expensing under Code Section 179 which has entirely separate rules, see above.

The 100% expensing is also available for certain productions, such as qualified film, television, and live staged performances, and certain fruit or nuts planted or grafted after September 27, 2017.

50% bonus first year depreciation can be elected over the 100% expensing for the first tax year ending after September 27, 2017.

4. Pension and profit-sharing plans: Only enter contributions you made for your employees on Schedule C. If you also made contributions for yourself, report those on your 1040.

5. Travel, meals and entertainment: For business travel, deductible expenses include:

• Lodging
• Transportation
• Tips
• Fax services
• Internet connections
• Some other incidental expenses

You'll see that travel is reported separately from business meals and entertainment:

• For tax years prior to 2018, you can deduct only 50 percent of your allowable meals and entertainment expenses.
• Beginning in 2018, generally, only meals are 50 percent deductible while entertainment is not deductible at all.
• For tax years 2021 and 2022, there is an exception for qualified business meals provided by a restaurant. In these cases, the meals are 100 percent deductible.

6. Wages: This category may seem straightforward, but can be a little tricky if you produce and sell goods. You should report amounts paid to employees, such as bookkeepers, receptionists, salespeople, etc., here. However, If you have production workers, you'll report their wages as part of the cost of goods sold in Part III.

7. Expenses for business use of your home: You qualify for this deduction if you use part of your home regularly and exclusively for your business. To qualify, your home office must be:

• Located in a separate area in your home where you don't mix business with other activities
• Used for business on an ongoing basis, not just once in a while

You calculate the home office deduction first on Form 8829: Expenses for Business Use of Your Home and then enter the result here.

Once you've entered all your deductions, subtract them from your gross income to get your net Schedule C profit or loss. The net income amount is then transferred to your Form 1040.

Do you have a loss? Then you're not done, yet. You have to go through some additional steps in this section before transferring that loss to your 1040, because it may not be fully-deductible.

• You must declare whether you're fully "at risk" for amounts invested in the business.
• If you are, then you can go ahead and take the full write-off.
• If not, you'll have to fill out Form 6198: At-Risk Limitations to determine if your deduction is limited.

Part III: Cost of goods sold

This section is for any business that sells goods to customers, so skip Part III if you're in a service business—consultant, yoga teacher, software programmer, day care center owner, etc.

Start by reporting the value of your inventory at the beginning of the year. This amount is usually the same as what you reported for closing inventory on last year's Schedule C.

Next, report the following costs and add them to your beginning inventory:

• Merchandise, but don't include the value of anything withdrawn from sale or for your personal use.
• Wages paid to production workers, factory supervisors and the like, if you're in manufacturing or construction.
• Expenses for supplies and other overhead.

From that total, subtract the value of your closing inventory. The result is your cost of goods sold. Enter that amount in Part I to reduce your gross income.

Part IV: Information on your vehicle

In this section, you give the IRS information about any vehicles for which you're deducting expenses in Part II. The IRS uses the answers in this section when reviewing your vehicle deduction to see if it seems legitimate. So it's important, for example, to be able to answer YES to the question about whether you have written documentation for your deduction. If you answer NO, don’t be surprised if the IRS asks you to justify the deduction.

Part V: Other expenses

If you have business costs that don't fit into the categories listed in Part II, detail and report the total of those expenses on the line for "Other Expenses" in Part V.

Examples of other possible business expenses include:

• Membership dues for professional organizations
• Subscriptions to business publications
• Fees you paid to credit card companies for processing customer card transactions
• Business-related gifts to suppliers, clients, contractors, etc.

Don’t worry about knowing which tax forms to fill out when you are self-employed, we here at TurboTax Live! have got you covered!!!

TurboTax Self-Employed will ask you simple questions about you and your spouse's business  - and give you the business deductions you deserve based on your answers.  TurboTax Self-Employed uncovers industry-specific deductions. 

We trust and are hopeful that this reply is responsive to the questions that you raised in your post.  We are happy to provide you with resources and materials toward answering your questions.

If you have any further questions, please do not hesitate to contact us and set up a call back or a Chat session with one of our Live! tax experts.

In the meantime, we thank you for contacting TurboTax Live! with your questions . . . and we wish you and your spouse all of the success in your self-employed business venture!!  Cheers!