Leaving the security of a steady job to start a new business is an intimidating process for a number of reasons. Newly self-employed individuals become responsible for all aspects of their ventures, but it is important to remember that you are not alone. Common knowledge in the entrepreneurial realm is to surround yourself with the right people, and my recent experience starting a business has taught me the value of this advice.
Over the last several years, I have received a number of inquiries related to the income tax requirements and responsibilities of individuals making this leap. While this is a broad, dynamic topic that affects each business owner uniquely, there are several topics that almost universally crop up during these discussions. They are routinely applicable to entrepreneurs, and they serve as essential aspects of taxation for the self-employed. These topics, and a brief explanation of their application, are listed below:
- Quarterly Estimated Tax,
- Car & Truck Expenses, and
- Business Use of Your Home (Home Office).
Quarterly Estimated Tax
First and foremost, self-employed individuals and business owners are required to remit taxes to regulatory agencies, such as the Internal Revenue Service (IRS), Louisiana Department of Revenue (LDR), Louisiana Workforce Commission (LWC), etc. This is primarily accomplished by figuring and paying estimated tax on a quarterly basis. As an employee of another business, this responsibility was handled by your employer (through withholdings from routine paychecks).
Estimated tax is the method used to pay tax on income that is not subject to withholding. It is also used to pay both income tax and self-employment tax, as well as other taxes and amounts reported on your tax return. This includes income from self-employment, interest, dividends, alimony, rents, gains from the sale of assets, prizes, and awards.
As a general rule, you must pay estimated tax if both of the following apply.
- You expect to owe at least $1,000 in tax for the year, after subtracting your withholding and refundable credits, and
- You expect your withholding and refundable credits to be less than the smaller of:
- 90% of the tax to be shown on your tax return, or
- 100% of the tax shown on your prior year’s tax return (assuming your prior year’s tax return covered all 12 months)
Estimated taxes are generally paid quarterly using Internal Revenue Service (IRS) form 1040-ES. To calculate estimated tax for the year, you must estimate your adjusted gross income (AGI), taxable income, taxes, deductions, and credits. It may be helpful to start with the amounts of these items from your tax return for the previous year and make adjustments to reflect known and/or assumed changes for the current year. The instructions to IRS form 1040-ES include an Estimated Tax Worksheet.
For estimated tax purposes, the year is divided into four (4) payment periods. In general, the due date for each quarterly installment of estimated tax is as follows:
|Quarterly Installment||Dates of Quarter||Due Date|
|1st Quarter||Jan. 1 – March 31||April 15th|
|2nd Quarter||April 1 – May 31||June 15th|
|3rd Quarter||June 1 – Aug. 31||September 15th|
|4th Quarter||Sept. 1 – Dec. 31||January 15th|
Car & Truck Expenses
If you use your car or truck for business purposes, you ordinarily can deduct expenses related to its business usage. There are two (2) methods available to choose from in figuring your deductible expenses, as follows:
- Standard Mileage Rate, and
- Actual Car/Truck Expenses.
Standard Mileage Rate. You may be able to use the standard mileage rate to figure the deductible costs of operating your car/truck for business purposes. If you choose the standard mileage rate method for a tax year, you cannot deduct actual car/truck expenses (i.e., gasoline, insurance, repairs/maintenance, depreciation, oil, vehicle registration, etc.).
If you want to use the standard mileage rate method for claiming car/truck deductions on your tax return, you must select it in the first year the car is available for use in your business. Then, in later years, you can choose to use either the standard mileage rate or actual expenses. Self-employed individuals and business owners have until the due date of their return (including extensions) to make this election.
Actual Car/Truck Expenses. If you do not use the standard mileage rate, you may be able to deduct your actual car/truck expenses. Actual car/truck expenses include:
|Ø Gasoline||Ø Oil/Oil Changes||Ø Licenses|
|Ø Parking Fees||Ø Tolls||Ø Tires|
|Ø Registration Fees||Ø Depreciation||Ø Insurance|
IMPORTANT NOTE: It is common to use a car/truck for personal and business purposes. In this case, you must divide your expenses between business and personal use. Making this determination can be based on the number of miles driven for each purpose.
Business Use of Your Home (Home Office)
Self-employed individuals and business owners often utilize a home office as their initial work space during the start-up phase of a new venture. The costs associated with maintaining a home office may qualify as a tax deduction on annual returns. To qualify to deduct expenses for business use of your home, you must use part of your home:
- Exclusively and regularly as your principal place of business (defined later),
- Exclusively and regularly as a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business,
- In the case of a separate structure which is not attached to your home, in connection with your trade or business, or
- On a regular basis for certain storage use.
Exclusive Use. To qualify under the exclusive use test, you must use a specific area of your home only for your trade or business. The area used for business can be a room or other separately identifiable space, and it is not required to be marked off by a permanent partition. However, you do not meet the requirements of the exclusive use test if you use the area in question for both business and personal purposes.
Regular Use. To qualify under the regular use test, you must use a specific area of your home for business on a regular basis. Incidental or occasional business use is not considered regular use. All facts and circumstances must be considered in determining whether your use of a home office is on a regular basis.
Calculating the Deduction. After making the determination that you qualify to deduct expenses for a home office, you can use one of the following methods to calculate your deduction:
- Actual Expenses, or
- Simplified Method
Actual Expenses Method. To calculate your deduction using the actual expenses method, you must divide the expenses of operating your home between personal and business use. Determining the portion of your home used for business purposes is generally figured based on the square footage of your home office as a percentage of your home’s total square footage. Actual expenses of a home office include (but are not limited to) the following:
- Rent paid for use of property not owned (but used in your business),
- Security System, and
Simplified Method. The simplified method is an alternative to the actual expenses method, and it is calculated by multiplying $5, the prescribed rate, by the area of your home used for business purposes. The area used to figure your deduction is limited to 300 square feet. As such, the simplified method provides a maximum deduction of $1,500.