Income from self-employment

3 key takeaways

• Income from self-employment includes all earnings generated from independent work, such as business profits, freelance work, consulting fees, and other self-directed activities.
• Self-employed individuals are responsible for managing their own taxes, including income tax, self-employment tax (covering Social Security and Medicare), and often need to make estimated tax payments throughout the year.
• Managing income from self-employment requires careful financial planning, including tracking expenses, setting aside money for taxes, and maintaining accurate records.

What is income from self-employment?

Income from self-employment encompasses all the earnings that an individual generates through their own business or independent work. This can include profits from operating a small business, fees for freelance or consulting services, and any other revenue streams derived from self-directed work. Unlike salaried employees, self-employed individuals do not receive a regular paycheck from an employer and must handle their own financial management and tax obligations.

Sources of self-employment income

Self-employment income can come from various activities, such as:

Freelancing: Earnings from providing services like writing, graphic design, programming, and other tasks on a contract or project basis.

Consulting: Fees charged for providing expert advice in areas like business strategy, marketing, finance, or technology.

Business Ownership: Profits from running a business, whether it’s a sole proprietorship, partnership, or small corporation.

Gig Economy: Income from participating in gig economy activities, such as driving for ride-sharing services, delivering food, or renting out property on short-term rental platforms.

Sales: Revenue from selling products or services online, at markets, or through other channels.

Managing income from self-employment

Tracking Income and Expenses: Self-employed individuals must keep detailed records of all income and expenses. This includes invoices, receipts, and bank statements. Using accounting software can help manage finances and prepare for tax filings.

Setting Aside Taxes: Self-employed individuals are responsible for paying their own taxes. This includes income tax and self-employment tax, which covers Social Security and Medicare contributions. It’s important to set aside a portion of income for taxes and make quarterly estimated tax payments to avoid penalties.

Deductions: There are various deductions available to self-employed individuals that can reduce taxable income. These can include business expenses such as office supplies, travel, marketing, and home office costs. Keeping detailed records of these expenses is crucial for maximizing deductions.

Retirement Planning: Unlike employees who might have access to employer-sponsored retirement plans, self-employed individuals must set up and manage their own retirement savings. Options include SEP IRAs, Solo 401(k)s, and SIMPLE IRAs.

Taxation of self-employment income

Self-employment income is subject to both income tax and self-employment tax:

Income Tax: This is the standard tax on earned income. Self-employed individuals must report their earnings on Schedule C (Profit or Loss from Business) and attach it to their personal tax return (Form 1040).

Self-Employment Tax: This tax covers Social Security and Medicare contributions. It is calculated on Schedule SE and is typically higher than the payroll taxes paid by employees because self-employed individuals pay both the employer and employee portions.

Example of self-employment income management

Example: Freelance Graphic Designer

A freelance graphic designer earns $60,000 per year from various clients. Here’s how they might manage their income:

1. Tracking Income: Use accounting software to track all invoices sent and payments received.
2. Expenses: Deduct business-related expenses, such as software subscriptions, marketing costs, and office supplies, totaling $10,000 for the year.
3. Net Income: Calculate net income as $60,000 – $10,000 = $50,000.
4. Taxes: Set aside approximately 30% of net income ($15,000) for income and self-employment taxes.
5. Quarterly Payments: Make estimated tax payments each quarter to cover both income tax and self-employment tax.
6. Retirement Savings: Contribute to a Solo 401(k) or SEP IRA to plan for retirement.

Related topics

• Freelancing
• Small business management
• Tax planning for self-employed individuals
• Business expenses and deductions

Explore these related topics to gain a deeper understanding of managing self-employment income, the unique financial and tax challenges faced by self-employed individuals, and strategies for effective financial planning and compliance.