Newly Self-Employed? Avoid These First-Time Tax Filing Mistakes

When you work for someone else, your tax filing requirements are pretty basic. Your employer is responsible for withholding the proper amount of taxes from every paycheck, and at the end of the year, your only job is to settle up with the federal IRS (in the U.S.).

The world of tax filing is far different, and much more complicated, for the self-employed, something many newly self-employed men and women are finding out the hard way. As the so-called great resignation plays out and the number of self-employed individuals continues to climb, it has never been more important to engage in some advance tax planning. If you are newly self-employed, here are some common first-time tax-filing mistakes you should take pains to avoid.

Not Tracking Your Earnings Carefully Enough

One of the most common first-time tax-filing mistakes self-employed people make is failing to track their earnings carefully enough. Those newly self-employed men and women may have a vague sense of how much they are making, but without hard numbers, filing taxes will prove extremely difficult.

It is easy enough to avoid this common problem, and a simple spreadsheet is all that’s needed. If you want something more advanced, a small business accounting program can make income tracking even easier. This simple step will make tax filing easier, but it will also allow you to analyze your earnings by client, by project, and any other metrics you choose.

Relying on Your Clients for Reporting

Another common tax-filing blunder self-employed individuals make is relying on their clients for the reporting. While there are rules in place that require certain clients to issue 1099 tax documents, these requirements are not universal, and not all clients will provide the information. This is especially the case if your client lives in another country.

Instead of relying on your clients to report your earnings, be sure to track every dollar you make, no matter where it comes from or who is providing it. Keeping track of expenses is important as well, so use your favorite spreadsheet or accounting program to complete the task.

Failing to Pay Estimated Quarterly Taxes

Those who work for traditional employers can rely on the companies they work for to withhold the right amount of tax. For the self-employed, however, there is no tax withholding at all. Yet, that does not mean you have no taxes due.

Many newly self-employed people fail to pay the taxes they owe ahead of time, and they end up with underpayment penalties, accrued interest, and other costly problems. If you are newly self-employed, you will need to pay estimated taxes on a quarterly basis, and failing to do so could prove quite costly.

Not Setting Money Aside for Additional Taxes

Submitting quarterly tax payments to the IRS may be cumbersome, but it does have one important benefit. When you know a payment is coming up, you force yourself to set money aside. However, that may not be enough.

The only thing worse than finding out you owe additional money to the IRS is not having the money you need to pay the tab. As the tax deadline approaches, you will want to set additional money aside just in case. If you do not need it, so much the better. If you do, you will be glad that it’s there.

Overlooking Valuable Tax Deductions

Being self-employed can be costly from a tax perspective, but it’s not all doom and gloom. When you work for yourself, you may be eligible for additional tax deductions, and taking advantage of them could lower the tab significantly.

The newly self-employed may not know what these potential deductions are, and that could cause them to overpay the IRS. If you are new to self-employment, be sure to check out the potential savings a solo 401(k) plan, health savings account (HSA), and home office deduction can provide.

In addition to those tax deductions, the self-employed may be able to deduct the cost of necessities such as Internet access and phone service. Consulting with a tax professional is always a good idea for the newly self-employed, as a tax pro can identify the potential savings and provide valuable advice.

Failing to Set Up a Separate Bank Account

Another mistake newly self-employed individuals make is not setting up a separate bank account for their business-related earnings. This can be a big mistake come tax time, and not keeping the finances separate can make it difficult to track earnings and deductions.

When you are self-employed, you are essentially running your own business. It may be a business of one, but it’s still a business, and setting up a separate bank account is a very smart idea. There are many advantages to having a separate bank account for your business, and the sooner you open one the better.

Not Getting an EIN

Last but not least, many self-employed men and women overlook the advantages of getting an employer identification number, or EIN. Similar to a Social Security number, the EIN is a unique identifier belonging to a business, and even those who are sole proprietors are eligible.

If you are self-employed, the IRS considers you both employer and employee, and that makes you eligible for an EIN. This unique number is available for free at the IRS website, and self-employed individuals can complete the process in a matter of minutes.

Some of the most lucrative tax deductions for the self-employed, including the solo 401(k) with its generous contribution limits, require an EIN, so getting one at the beginning can have valuable benefits. An EIN may also be required to open a business bank account or apply for a small-business loan.

The shift to gig work and self-employment is one of the most important business stories of the last decade, and the trend shows no signs of slowing down. More and more people are taking their futures into their own hands and choosing freelancing and self-employment, but many of them are surprised at just how complicated the tax situation can become. If you are newly self-employed, you should take pains to avoid the first-time tax filing mistakes outlined above.