Being self-employed is the ultimate career goal for many. The freedom to create your own schedule, choose projects, and control your workload has always inspired self-employment, but in recent years, the number of startups has been growing. In 2020, so-called ‘pandemic entrepreneurs’ started over four million new businesses: the highest total currently on record.
Although the transition to self-employment appears to be at an all-time high, many startups fail within the early years, indicating that certain things need to be in place for a business to succeed. One of them is knowledge of the tax requirements and deductions aimed at Minnesota entrepreneurs. In this blog, we go over the various Minnesota self-employment help strategies you should be aware of.
Federal Self-Employment Taxes Explained
If you have your own business in Minnesota, you are required to pay a self-employment tax, which is currently 15.3%. This tax covers Social Security (12.4%) and Medicare (2.9%). There are two calculations you’ll need to make:
- Apply the 12.4% for Social Security for the first $147,000 of your net earnings. (Note: this amount, which is current for 2022, changes every year.)
- Apply the 2.9% for Medicare to your combined net earnings. If these earnings exceed $200,000 ($250,000 if you’re filing jointly with a spouse), an additional 0.9% may apply.
Self-employment tax must be paid quarterly. You can use the worksheet on Form 1040-ES, Estimated Tax for Individuals, to determine if you must file quarterly estimated taxes on:
- April 15
- June 15
- September 15
- January 15
To reduce the risk of an underpayment penalty, it is recommended that you remit at least the same amount in taxes that you did the year before (if you worked for yourself then too). Check your previous year’s tax return to determine the total amount you paid, divide the number by four, and send a payment on each of the four due dates above.
If it turns out that you owe more tax this year, you’ll still have to pay it but you won’t be subject to an underpayment penalty. For example, if you paid $8,000 in taxes last year, you’ll send in four equal payments of $2,000 this year. If you discover at tax time that your total obligation is actually $10,000, you can remit the additional $2,000 without incurring a penalty.
If you find that your self-employment income fluctuates from one year to the next, you can use IRS Form 1040-ES to calculate your expected liability while allowing for certain frequently-claimed deductions.
Tax Deductions for the Self-Employed
As a business owner, you have to shoulder certain costs that employees don’t have to worry about, such as renting office space and business use of a vehicle. To make self-employment more sustainable, legislators have approved certain tax deductions that constitute a significant self-employment benefit.
When the Tax Cuts and Jobs Act took effect for the 2018 tax year, it made several important changes to self-employment tax deductions, including the qualified business income (QBI) deduction for those who pay taxes as an individual taxpayers rather than through a corporation. This deduction can apply to up to 20% of your QBI, which is the net amount of your income after gains, losses, and deductions have been applied.
Below are some of the tax deductions you may be able to make:
- Home Office: You can deduct home office expenses for any home workspace you use regularly and exclusively for your business, regardless of whether you rent or own it. This includes the business percentage of your rent, mortgage interest, utilities, homeowner’s insurance, and similar expenses.
- Office Rental: The amount you pay for renting an office space can be deducted as a business expense. If you rent equipment, you can also deduct the amount you paid.
- Phone and Internet: You can deduct the business percentage of your phone and Internet expenses even if you don’t claim the home office deduction.
- Vehicle Use: Your car expenses are tax-deductible when you use it for business purposes. Either the IRS’s standard mileage rate or your actual expenses can be used to calculate your deduction. In either case, you will need to support the deduction you claim with contemporaneous documentation of your business travel that establishes both the miles driven and the business purpose for each trip.
- Health Insurance Premiums: If you pay for your health insurance premiums, you can deduct all of your health, dental, and qualified long-term care insurance premiums.
- Travel: Travel undertaken for business purposes, such as meeting new clients, soliciting prospects, or learning new skills related to your industry, is deductible.
- Meals: Meals eaten while traveling for business or entertaining a client are currently 100% deductible under the Consolidated Appropriations Act, although this is set to change at the end of 2022.
- Interest on Business Loans: The interest on a bank loan for a business is deductible as a business expense. In the case of loans used for both personal and business purposes, the business percentage of the interest is determined according to how you use the money.
Hidden Expenses to Be Aware Of
When you’re employed, you take certain things for granted, like health insurance and paid time off. These perks are all part of a standard benefits package but when you’re self-employed, you have to plan for them.
Vacations, sick days, and holidays must be added to your billable hours. A standard benefits package of two weeks off, five sick days, and ten paid holidays equals five weeks off per year. As a freelancer, you need to charge around 10% more than your hourly rate as an employee to compensate for five weeks off.
Another major perk of being self-employed is setting up a home office and avoiding the commute. However, running a business out of your house still costs money. Even if your computer works fine now, it will eventually need replacing. In order to make your at-home setup more ergonomic, you may need to buy a new chair or desk or purchase a computer monitor. Since you’re staying home all day, you’ll probably see an increase in your utility bills as well. These are all hidden expenses you need to account for.
Why You Should Speak to a Minnesota Tax Lawyer
When you’re looking for Minnesota self-employment help, one of your best resources is a tax attorney. If you’ve never worked for yourself before, you may be unfamiliar with self-employment taxes, approved deductions, and quarterly tax remittances. A Minnesota tax attorney can not only help you get started on the right foot but also provide advice and representation if you are audited by the IRS or the Minnesota Department of Revenue. Tax controversies can be stressful, and experienced legal help can help secure the best outcome.
Need Minnesota Self-Employment Help? Speak to a Tax Lawyer!
Having your own business is exhilarating and rewarding, but there’s a lot of financial and tax planning involved. You’ll want to maximize your business deductions each year to mitigate the additional expenses of being self-employed, but sometimes the government steps in to question or deny a claim. If the IRS challenges any of your deductions, Pridgeon & Zoss, PLLC offers skilled and experienced representation.
Located in Edina and Roseville, we serve self-employed clients throughout Minnesota and western Wisconsin. We can help you defend the credits and deductions you claimed on your tax forms or represent you when there is a dispute with the MDR or IRS. If you have questions or need assistance, please contact us for a free half-hour initial consultation. We look forward to supporting your success.