Did you know that as a self-employed consultant, you are responsible for income taxes ranging from 10% to 40% of your net profit? Yes, this is true!
Also, did you know that you are required to keep certain tax documents for a specific period, and there's a certain way you must file your taxes? Yes, this is true!
You must be aware of so many tax requirements as a self-employed consultant.
Well, have no worries because I will identify how you, as a self-employed consultant, should keep track of your income and expenses and how you should pay and file taxes for 2022.
Most consultants, as a matter of fact, most business owners dread tax season. Do you?
Instead of dreading tax time, how about you position your consulting firm to have a worry-free tax season. Sounds promising? To accomplish this, there are items and tasks a consultant must implement.
This post will answer some of the basic frequently asked questions regarding self-employed taxes for consultants. These questions were pulled from our social media comments.
1. How to determine if you are self-employed?
Most consultants are self-employed. According to the IRS, you are self-employed if you're a business owner or contractor who provides services to other businesses.
For example, you are a self-employed consultant if you provide services to your client and they pay the full amount without deducting taxes. For example, your project or service cost $2,500, and they paid you $2,500.
In this case, you are responsible for your taxes, not your client. If this is you, keep reading.
2. How Does Self-Employment Taxes Work
As a self-employed consultant, in most cases, you are required to pay both federal income taxes and self-employment taxes.
The amount you will owe for income taxes will depend on your tax bracket and your yearly net profit amount. The amount could range between 10% to 40%.
As a self-employed consultant, you must also pay 15.3% for self-employment taxes.
If you expect to owe more than $1,000 in federal taxes, you're also required to pay estimated quarterly taxes.
And depending on where you are located, you may be required to pay taxes to your city, local, and state.
3. How To Determine your Net profit?
To determine your monthly and yearly Net Profit, you want to make sure your monthly income and expenses are organized in an accounting system.
Each month, your bookkeeper should match your bank statements with your accounting system and prepare an income statement, also known as a Profit and Loss Statement.
This financial statement will identify your Net Profit for a particular period of time.
You will use this information to determine your business's tax liability for the year. You will factor this information along with your personal tax information if you are an LLC or sole-proprietor to determine your total tax liability.
4. For tax purposes, what documents should you keep?
Along with having an accurate accounting system, you should also keep a document trail of your purchases and income for tax purposes as a self-employed consultant.
For example, for all business expenses you plan to claim as deductions on your tax return, the IRS requires you to keep supporting documentation that shows what you purchased, how much you paid, and when you purchased it.
The IRS requires businesses to keep receipts for all business expenses of $75 plus. Note that if your business is audited, you'll still need to be able to provide basic information about expenses under $75.
I recommend using your accounting system or an online file system to scan and keep all receipts, no matter the dollar amount.
With most accounting systems, you can scan and attach a copy of your receipts and source documents to the transactions. I recommend you keep digital copies of everything, not physical copies, because, over time, physical copies will fade.
You also need to keep proof of income received, such as invoices, digital payments, cleared checks, 1099s forms, etc.
5. How long should you keep your financial records?
The IRS requires you to keep all source documents for a minimum of three years.
However, for special circumstances, you are required to keep records for a longer time.
For example, if you underpaid your taxes by 25% or more, the IRS can go back as far as six years. But, in most cases, you are not aware that you underpaid your taxes until you receive that dreaded, heart-wrenching letter in the mail from the IRS.
Therefore, a good rule of thumb is to keep your receipts and source documents for at least six to seven years.
In closing, please understand that paying taxes is not a bad thing, believe it or not. If you are earning and KEEPING more money in your business as a self-employed consultant, at some point, you will owe taxes.
The goal is to pay the smallest legal amount possible. To accomplish this, you must have your accounting records in order and not wait until the last minute.
Of course, if you need assistance, don't hesitate to schedule a Discovery Session with our team today.