How the Self-Employed Pays Taxes

Business owners, gig workers, and independent contractors are considered self-employed. You may be one of these if you own a local business, you take on one-time gigs, or you work on a contract and receive a 1099 at the end of the year.

Examples of independent contractors include doctors, dentists, veterinarians, lawyers, accountants, public notaries, carpenters, electricians, plumbers, mechanics, stonemasons, home remodelers, housecleaners, lawn care providers, babysitters, news carriers, software developers, web designers, graphic artists, entertainers, guest speakers, truckers, cab drivers, farm workers, interpreters, project managers, hairstylists, salespeople, and freelance writers.

You are considered self-employed if you carry on a trade or business (not just a hobby) or you are in business for yourself whether it is full-time or part-time. A self-employed person can be a sole proprietor, an independent contractor, or a freelancer. You are considered self-employed even if you are paid in cash and do not receive a 1099-MISC or 1099-NEC.

See a comprehensive Small Business Tax Guide if you complete Schedule C. Use eFile.com to prepare your small business tax return and discuss your situation with one of our Taxperts^®; self-prepare, but not alone!

Here is a quick look at how you get paid and pay taxes being self-employed versus as an employee:

• Employee: Paid through a routine paycheck reported at the end of the year on Form W-2; taxes are withheld by submitting a W-4 and the employee will fill out a Form 1040 when they file their income taxes.
• Business Owner: Paid through income through business transactions and may have a Form 1099-NEC or MISC, Form 1099-K, or Schedule K-1. Note: files a Form 1120 business tax return via Schedule K-1 if they have a corporation. Taxes are paid quarterly by the business owner and they will file a 1040 Return with Schedule C and Schedule SE.
• Independent Contractor: Paid by the person or business which they have a contract with and they should be sent a Form 1099-NEC, 1099-MISC, or Form 1099-K. Taxes are paid quarterly by the contractor and they will file a 1040 Return with Schedule C and Schedule SE.

An employee and a contractor have different aspects that define their role.

• Employee: the company or business controls the work you do and how the work is performed; they gave the right to direct and control all financial aspects of the job. This includes the tools and equipment invested in, determine pricing and wages, and helps withhold tax from your pay.
  
  • The occupation is expected to be permanent or at least relatively long-term. You are also given employee benefits (insurance, pension, paid vacation, sick pay, etc.) if you are full-time.
• Self-employed: You have the right to direct and control the business and financial aspects of your job. You may also have business expenses which you can deduct. You can invest in the facilities, equipment, or tools used in performing your job, make your services available to the open market, set your own rate and prices for services, not have taxes withheld from your pay, and have the possibility of incurring a loss.
  
  • Services you provide are not a key aspect of the regular business of the company. The relationship may not be permanent and the company does not give you employee benefits, you provide them for yourself, sometimes through the business.

You are considered an independent contractor if the person or organization that pays you has the right to direct and control only the result of the work and not what work will be done or how it will be done.

• Independent Contractor: You provide services as a self-employed individual, not as an employee. If you are self-employed and an independent contractor, your compensation is reported on Form 1099-MISC or Form 1099-NEC (along with rents, royalties, and other types of income). If you received a 1099 form instead of a W-2, then the payer of your income did not consider you an employee and did not withhold federal income tax or Social Security and Medicare tax. A 1099-MISC or NEC means that you are classified as a nonemployee which makes you self-employed.
• Trade or business: this is an activity carried out to make a profit. Even if you don't actually make a profit, you are still carrying out a trade or business as long as your motive is to make a profit and you make regular, ongoing efforts to further the interests of your business. A trade or business may be full-time or part-time and it may be carried out in addition to regular employment.
• A hobby is not a trade or business. If you carry on an activity that occasionally produces income, but your main purpose for pursuing the activity is not for profit, then you might be engaged in a hobby. Hobby income should be reported as other income on your tax return. If you itemize deductions, you can deduct hobby expenses up to the amount of your hobby income. See the tax return filing requirements to find out if your hobby income requires you to file a tax return and learn more about hobby income.

You may establish a limited liability company or LLC, a corporation, sole proprietorship, or other business entity form which may affect your taxes.

See also: family businesses and taxes.

You can lower your self-employment taxes by writing off expenses and claiming the Qualified Business Income Deduction or QBI. You should keep detailed records of any purchases you make for your business so that you can deduct them on your taxes which directly reduce your business income. If you have more expenses than income, you may have a loss and thus pay no taxes - plus, your loss carries forward so you can deduct it the following year.

Deduct these as they apply: miles you drove for business or vehicle expenses, business meals, computer upkeep or a new computer, furniture for your office, software licenses, tools and equipment, your phone and monthly bill, and other expenses that benefit your business.

The QBI deduction allows you to deduct up to 20% of qualified business income if you are self-employed or are a small business owner. The deduction is allowed whether you itemize or not since it is done on a separate form (Form 8995 - eFileIT) and then added to Schedule C. The deductible amount depends on your total taxable income including wages, interest, and capital gains in addition to income generated by your business. The deduction limits are based on the income level and type of business.

When you prepare and e-file your return on eFile.com, you don't need to worry about income levels and how to calculate the QBI deduction as we will do all that for you.

In the QBI table below, find the deduction phaseout thresholds by tax year.

If you have a loss on your business - if you lose money by having more expenses than income - then this is deductible by certain limits. You can generally carry this forward each year as a net operating loss if your loss is in excess of your taxes, limited by $250,000 ($500,000 for married filing jointly for the 2023 tax year.

Self-employed health insurance premiums - medical insurance, dental insurance, and qualified long-term care insurance - may be up to a 100% tax deduction on your 1040 tax return if you showed a profit for the year. This includes you, your spouse, dependents, and children who are younger than 27 at the end of the tax year, even if the children aren’t your dependents. Your health insurance from the Marketplace is reported on Form 1095-A; see how to add Form 1095-A to your return.

For example: your annual health insurance premium was $5,000 and your profit for the year was $8,000: you could deduct 100% of your premium. With a $5,000 premium and a $4,000 profit, you could deduct $4,000. If your business showed a loss, you could not deduct any self-employed health premium payment.

Keep in mind, you can’t take the premium deduction if you were eligible for group insurance from your or your spouse’s employer. Included are reimbursements via a Qualified Small Employer Health Reimbursement Arrangement (QSEHRA). The total amount of payments and reimbursements for a QSEHRA cannot exceed $6,150 and $12,450 for family coverage for the 2023 tax year, up from $5,450 and $11,050 last year.

Self-employed retirement plans can be set up by you, allowing you to deduct some or even all of your contributions when you are not covered by a workplace retirement plan. Self-employed SEP, SIMPLE contributions will show on Line 15 on Schedule 1 of your 1040 tax return. See more information on retirement and taxes or view this IRS Publication on Retirement Plans for Small Business - SEP, SIMPLE and Qualified Plans.

If you're a church employee earning $108.28 or more, you generally pay self-employment tax. Ministers, religious order members, and Christian Science practitioners may exempt their income if they meet certain criteria and file specific forms. However, income from other sources might still be subject to the tax.

If you are a minister (or priest, rabbi, etc.), a member of a religious order NOT under a vow of poverty, or a Christian Science practitioner, and you have a conscientious objection to Social Security insurance, you may exempt your net earnings from self-employment tax by filing Form 4361. Under certain circumstances, if you have a conscientious objection to Social Security because of your membership in a religious sect, you may be able to exempt your net income from self-employment tax by filing Form 4029

In general, two married spouses who jointly own an unincorporated business must file taxes for the business as a partnership. However, partnership tax returns and recordkeeping can get very complicated, so the IRS has made an exception. If a husband and wife are the only members of a joint venture (a fancy name for a business owned by two or more people), then they may agree together to elect for their business NOT to be treated as a partnership for federal tax purposes.

This makes it a Qualified Joint Venture. The couple files a joint tax return and prepares a separate Schedule C for each spouse, taking into account each spouse's share of income and loss derived from the business as if they were each a sole proprietor. Only couples that are married filing jointly can elect for their business to be a Qualified Joint Venture. Corporations and LLC's do not qualify for this election.