Finance 101 for eWorkers
- Tax BasicsBy Kristin Kane
Succeeding as an independent professional requires immense talent
and skill. But even if you are the best Web developer north of the
Rio Grande, you also need to know how to run a business. In this
first installment in a series of articles covering financial
management for independent professionals, we will address one of the
crucial financial issues facing independents--their dues to Uncle
Sam.
Self-Employment Tax
The IRS requires independent professionals to pay a so-called
'self-employment tax' of 15.3% (for 2001) to cover the social security and
Medicare taxes. Ordinarily an employer picks up half the tab for
these taxes, but self-employed people pay the entire amount
out-of-pocket. Even if you hold a regular job and only moonlight as
an independent, you may still have to pay self-employment tax. All
self-employment earnings totaling over $400 are subject to this
hefty tax. Fortunately, independents get to deduct half the amount
they pay in self-employment tax when they file their income taxes on
April 15.
Quarterly Filing
The federal income tax is what is known as a 'pay-as-you-go' tax,
meaning that it's due throughout the year. For people in traditional
jobs, employers withhold the appropriate amount and send it directly
to the IRS on behalf of the employee. But if you expect to owe at
least $1000 in income tax on April 15, the IRS requires you to make
quarterly payments of estimated taxes. Consequently, most
independent professionals pay their tithes to the government four
times a year. Independents who also hold traditional jobs can avoid
paying estimated taxes by asking their employer to withhold an
additional amount from each paycheck.
Business Expenses
Deducting ordinary business expenses is an important tool in
keeping your taxes down. Office supplies, postage, phone calls,
travel expenses, client lunches--and yes, even car mileage--are
deductible. In addition, the following larger deductions will help
keep the spring in your step.
Home Office. You may be able to deduct the cost of
maintaining a home office. In order to qualify for the deduction,
you must use your office "regularly and exclusively" for your
business. If you keep a spare bed or TV in your office, the IRS may
view that as evidence that the space is not used exclusively for
business. Your office does not necessarily need to be a separate
room. It can be part of a room, or even a closet. What matters is
that its boundaries are defined.
Additionally, your office must be one of the following: your
primary place of business, a freestanding structure not attached to
your home, or a place where you meet with clients.
Once you have specified the location and dimensions of your
office, you are entitled to deduct the cost of maintaining that
portion of your home. For instance, if your office space takes up
20% of your home, you can deduct 20% of your rent or mortgage, as
well as 20% of the other costs of maintaining your home, including
the utility bills.
Health Insurance. Health insurance, a big-ticket expense
for independent professionals, fortunately translates into a big
income tax deduction. Self-employed people are entitled to deduct 60% (for 2001) of the amount
they pay for health insurance for themselves and their families. This rate
is 70% for 2002.
Documentation
Thorough record-keeping is the bedrock of sound financial
management. With the IRS audit rates significantly higher for
independent professionals than for the general population, financial
records can make or break a business. So hold on to those receipts.
Additionally, many tax advisors suggest that you keep a journal of
your business activities and expenses.
Keep in mind that your state and local tax authorities may
also have specific requirements for self-employed people. If this is
your first year as an independent, you will probably want to get
some help from a professional tax advisor. The good news is that
mastering your taxes gets easier each time you file. And most
independents agree that it's a small price to pay for freedom.
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