Self-employment income tax basics

Working for yourself comes with a lot of freedom but can also increase complexity when filing taxes. Lay a foundation for successful tax planning by finding answers to your self-employment tax questions. Then, work closely with your tax professional and an Ameriprise financial advisor to help ensure your tax strategy is on the right track.

In this article:

• How does the IRS define self-employed? 
• What are self-employment taxes?
• What are my self-employment tax filing obligations?
• What are quarterly tax payments?
• What are eligible business deductions?
• Can I reduce my taxable income by contributing to a self-employment retirement plan? 
• Can I reduce my taxable income by contributing to a health care plan?

How does the IRS define self-employed?

Whether full-time or part-time, you are generally considered self-employed if any of the following situations apply to you:

• You work as a freelancer, sole proprietor or independent contractor.
• You own your own business (depending on what business structure you’ve created).
• You are, a partner in a partnership, or a member of an LLC (limited liability company).

What are self-employment taxes?

• Self-employment taxes are Social Security and Medicare taxes, similar to the Social Security and Medicare taxes withheld from an employee’s paycheck. 
• As a self-employed individual, taxes are not withheld from your income.  It is your responsibility to make quarterly payments, as discussed below.

What are my self-employment tax filing obligations? 

• Generally, self-employment tax obligations include filing an annual tax return, in addition to paying estimated tax on a quarterly basis.
• You are required to file an income tax return if your net earnings from self-employment were $400 or more.
• If your net-earnings are less than $400, you may still have to file a return if certain other filing requirements are met.
• If you’re not sure how to accurately calculate self-employment tax or how much to save for self-employment tax, consider reaching out to your tax professional.

What are quarterly tax payments?

The self-employed generally do not have income taxes, Social Security and Medicare taxes withheld from their income. Therefore, it’s up to you to make estimated tax payments, which the IRS requires on a quarterly basis.¹

To avoid potential tax consequences, underpayment penalties, additional interest, or back taxes when you file your annual tax return, you will need to pay your estimated taxes on a quarterly basis and by the IRS deadline.²

If your business has employees, you will have additional tax and withholding obligations beyond estimated quarterly tax payments. Discuss your situation with a tax professional to determine any additional requirements you may be responsible for.

What are eligible business expenses? 

You may be able to deduct certain business expenses, which may reduce taxable income. To be deductible, a business expense must be both ordinary and necessary:

• Necessary business expenses: A necessary business expense is one that is helpful and appropriate for your trade or business. 
• Ordinary business expenses: An ordinary expense is one that is common and accepted in your trade or business. 

Track your expenses during the year and keep accurate records of each expense. Work with your tax advisor to determine which expenses may qualify as deductible.

Can I reduce my taxable income by contributing to a self-employed retirement plan?

Planning for retirement when you’re self-employed is an important part of maintaining your livelihood in the future. When you contribute to these plans, you may be able to save on taxes and reduce your tax liability by:

• Taking a federal income tax deduction for enrolling in and funding a retirement plan.
• Reducing your taxable income.

There are several self-employed retirement account options available to choose from depending on your financial needs and goals, including:

• Solo 401(k), also known as the Self Employed 401(k)
• SIMPLE 401(k) Plan
• SIMPLE IRA (Individual Retirement Plan)
• Simplified Employee Pension (SEP) Plan

Contributions to the above plans generally can help lower your taxable income as they are made with pre-tax dollars. That means you won’t have to pay taxes on any of your contributions until you start taking distributions. Generally if funds are withdrawn without having reached 59.5 or having an exception, you will have to pay federal income tax and a 10% premature distribution penalty tax.

Solo Roth 401(k)s are another option for a self-employed retirement plan, but contributions to these kinds of plans will not lower your taxable income, as they’re made with after-tax dollars. However, future distributions from this plan are not subject to tax withholding when all conditions are met.³

The right type of retirement plan for you will depend on your business type, future needs and overall financial goals.

Can I reduce my taxable income by contributing to a health care plan?

If you are not covered by an employer plan, you may qualify for a self-employed health insurance deduction, which allows you to potentially deduct up to 100% of health insurance premiums. The deduction applies not just to your premiums, but to premiums you pay for your spouse and dependents.

You can also deduct contributions to a health savings account (HSA), considered an “above-the-line” deduction. When you withdraw funds from an HSA to pay for a qualified medical expense, those withdrawals aren’t counted as income. However, non-qualified medical expense withdrawals are.

Get financial advice personalized for your business

An Ameriprise financial advisor will partner with your tax professional to help you create or update the tax strategy for your self-employment venture or small business.

Visit the IRS website for access to forms, instructions and other publications.