Self-employed individuals, known as Sole Proprietors, are required to report their business income and expenses on Schedule C when they file their Form 1040 Federal Individual Income Tax Return. A sole proprietor is someone who owns an unincorporated business by him or herself.
Identification Numbers
Social Security Number (SSN): You generally use your SSN as your taxpayer identification number. You must put this number on each of your individual income tax forms, such as Form 1040 and its schedules.
Employer Identification Number (EIN): You must also have an EIN to use as a taxpayer identification number if you do either of the following.
- Pay wages to one or more employees.
- File pension or excise tax returns.
Income Tax
Do I Have To File an Income Tax Return? You have to file an income tax return if your net earnings from self-employment were $400 or more. If your net earnings from self-employment were less than $400, you still have to file an income tax return if you meet any other filing requirement listed in the Form 1040 instruction booklet.
How Do I File? File your income tax return on Form 1040 and attach Schedule C or Schedule C-EZ. Enter the net profit or loss from Schedule C or Schedule C-EZ on page 1 of Form 1040. Use Schedule C to figure your net profit or loss from your business. If you operated more than one business as a sole proprietorship, you must attach a separate Schedule C for each business. You can use the simpler Schedule C-EZ if you operated only one business as a sole proprietorship, you did not have a net loss, and you meet the other requirements listed in Part I of the schedule.
When is my tax return due? For 2013, Form 1040 is due by April 15th. If you use a fiscal year, your return is due by the 15th day of the 4th month after the end of your fiscal year. If you file late, you may have to pay penalties and interest. If you cannot file your return on time, use Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, to request an automatic 6-month extension.
How Do I Pay the Income Tax? The federal income tax is a pay-as-you-go tax. You must pay the tax as you earn or receive income during the year. An employee usually has income tax withheld from his or her pay. If you do not pay your tax through withholding or do not pay enough tax that way, you might have to pay estimated tax. You generally have to make estimated tax payments if you expect to owe taxes, including self-employment tax, of $1,000 or more when you file your return. Use Form 1040-ES, Estimated Tax for Individuals, to figure and pay the tax. If you do not have to make estimated tax payments, you may pay any tax due when you file your return.
Self-Employment Tax
The self-employment tax (SE tax) is a Social Security and Medicare tax for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of wage earners.
Who must pay self-employment tax?
You must pay SE tax and file Schedule SE if either of the following applies:
- You were self-employed and your net earnings from self-employment (excluding income described below) were $400 or more.
- You performed services for a church as an employee and received income of $108.28 or more.
SE tax rate
The SE tax rate on net earnings for 2013 is 15.3%. (12.4% Social Security tax plus 2.91% Medicare tax).
Maximum earnings subject to SE tax
The first $113,700 of your combined wages, tips and net earnings in 2013 is subject to the 12.4% Social Security tax.
All your combined wages, tips, and net earnings are subject to any combination of the 2.9% Medicare part of SE tax, Social Security tax, or railroad retirement (tier 1) tax.
If your wages and tips are subject to either Social Security or railroad retirement (tier 1) tax, or both, and total at least $113,700, you do not have to pay the 12.4% Social Security part of the SE tax, depending on when it was earned, on any of your net earnings. However, you must pay the 2.9% Medicare part of the SE tax on all your net earnings.
Employment Taxes
If you have employees, you will need to file forms to report employment taxes. Employment taxes include the following items:
- Social Security and Medicare taxes
- Federal income tax withholding
- Federal unemployment (FUTA) tax
For more information, see Publication 15, Circular E, Employer’s Tax Guide, which explains your tax responsibilities as an employer.
Accounting Periods
When preparing a statement of income and expenses (generally your income tax return), you must use your books and records for a specific interval of time called an accounting period. The annual accounting period for your income tax return is called a “tax year.” You can use one of the following tax years:
- A calendar tax year
- A fiscal tax year
You adopt a tax year when you file your first income tax return. You must adopt your first tax year by the due date (not including extensions) for filing a return for that year.
Calendar Tax Year
A calendar tax year is 12 consecutive months beginning January 1st and ending December 31st. You must adopt the calendar tax year if any of the following apply.
- You do not keep adequate records.
- You have no annual accounting period.
- Your present tax year does not qualify as a fiscal year.
If you filed your first income tax return using the calendar tax year and you later begin business as a sole proprietor, you must continue to use the calendar tax year unless you get IRS approval to change it. If you adopt the calendar tax year, you must maintain your books and records and report your income and expenses for the period from January 1st through December 31st of each year.
Fiscal Tax Year
A fiscal tax year is 12 consecutive months ending on the last day of any month except December. A 52-53 week tax year is a fiscal tax year that varies from 52 to 53 weeks. If you adopt a fiscal tax year, you must maintain your books and records and report your income and expenses using the same tax year.
Accounting Methods
An accounting method is a set of rules used to determine when and how income and expenses are reported. Your accounting method includes not only the overall method of accounting you use, but also the accounting treatment you use for any material item.
You choose an accounting method for your business when you file your first income tax return that includes a Schedule C for the business. After that, if you want to change your accounting method, you must generally get IRS approval.
Generally, you can use any of the following accounting methods.
Cash Method
Most individuals and many sole proprietors with no inventory use the cash method because they find it easier to keep cash method records. However, if an inventory is necessary to account for your income, you must use an accrual method of accounting for sales and purchases.
Income: Under the cash method, you include in your gross income all items of income you actually or constructively receive during your tax year. If you receive property or services, you must include their fair market value in income.
Expenses: Under the cash method, you must generally deduct expenses in the tax year in which you actually pay them. This includes business expenses for which you contest liability. However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs.
Accrual Method
Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to match income and expenses in the correct year.
Income—General Rule: Under an accrual method, you generally include an amount in your gross income for the tax year in which all events that fix your right to receive the income have occurred and you can determine the amount with reasonable accuracy.
Expenses: Under an accrual method of accounting, you generally deduct or capitalize a business expense when the following apply:
1. The all-events test has been met:
– All events have occurred that fix the fact of liability, and
– The liability can be determined with reasonable accuracy.
2. Economic performance has occurred.
Economic Performance: You generally cannot deduct or capitalize a business expense until economic performance occurs. If your expense is for property or services provided to you or for your use of property, economic performance occurs as the property or services are provided or as the property is used. If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. An exception allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred.
Inventories: You must generally take inventories into account at the beginning and end of your tax year when the production, purchase, or sale of merchandise is an income-producing factor. If you must account for an inventory in your business, you must use an accrual method of accounting for your purchases and sales.
Combination Method
You can generally use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. However, the following restrictions apply.
- If an inventory is necessary to account for your income, you must use an accrual method for purchases and sales. You can use the cash method for all other items of income and expenses.
- If you use the cash method for figuring your income, you must use the cash method for reporting your expenses.
- If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income.
Kinds of Income
You must report on your tax return all income you receive from your business unless it is excluded by law. In most cases, your business income will be in the form of cash, checks, and credit card charges. But, business income can be in other forms, such as property or services.
Property or Services (Barter)
Bartering is an exchange of property or services. You must include in your gross receipts, at the time received, the fair market value of property or services you receive in bartering. If you exchange services with another person and you both have agreed ahead of time on the value of the services, that value will be accepted as the fair market value unless the value can be shown to be otherwise.
Small Business Administration
The Small Business Administration (SBA) offers training and educational programs, counseling services, financial programs, and contract assistance for small business owners. The SBA also has publications and videos on a variety of business topics.
Personal Computer:With your personal computer and modem, you can access the SBA on the Internet at www.sba.gov. While visiting the SBA website, you can find a variety of information of interest to small business owners.
Phone:Call the SBA Answer Desk at 1-800-827-5722 for general information about programs available to assist small business owners.
Henssler Financial can assist small business owners with accounting and income tax preparation. For more information contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
