What Is Self-Employment Income?

Whether you’re a freelancer, sole proprietor, or member of a trade partnership, you’ll qualify as self-employed in the eyes of the IRS. It’s important to understand the definition of self-employment income so that you can report it accurately and stay on top of all tax obligations. It’s also important to learn how to better manage your self-employment income for a positive cash flow. So, what is self-employment income and what are your obligations? Here’s how to get started.

What is self-employment income?

According to the IRS, self-employment income refers to any income earned through a trade or business when you are a:

• Sole proprietor

• Independent contractor

• Member of a partnership

This trade or business doesn’t necessarily need to be your full-time job. Income earned from side gigs or part-time businesses also qualify, provided you’re in business for yourself. If profit isn’t the motive behind this activity, it’s instead defined as a hobby by the IRS and wouldn’t be subject to self-employment tax obligations.

By contrast, any income received as an employee wouldn’t qualify as self-employment income. Employees can work at home or in the office, but if the work is at the direction of an employer, you should receive regular paychecks and a corresponding W-2 form at tax time.

Self-employment income tax obligations

Most self-employed individuals will need to pay quarterly estimated taxes in addition to filing an annual return. In addition to paying income tax like employees, the self-employed must pay an additional self-employment tax to cover the cost of Social Security and Medicare. This is because there is no employer to withhold these taxes from a regular paycheck.

To find out whether you’re responsible for paying taxes on your self-employment income, you should calculate your business’s net profit or net loss. You’ll need to file an income tax return if net earnings are above $400 for the tax year, or you meet additional filing requirements listed on the Form 1040 and 1040-SR.

Additional IRS tax forms you’ll likely need to fill out include:

• Form 1040-ES to calculate your quarterly estimated tax payments based on prior returns

• Schedule C to report income or loss as a self-employed individual

• Schedule SE to report Social Security and Medicare taxes

• Schedule F if you are a farmer

• Schedule K-1 if you are a member of a partnership

Challenges when managing self-employment income

Successfully managing self-employment income requires a realistic budget. One of the main challenges that self-employed individuals must overcome is the ability to manage cash flow. You’re responsible for managing all expenses as well as ensuring you get paid. When invoices and customer payments are delayed, it creates cash flow problems.

Another factor to consider is estimating and paying the self-employment taxes outlined above. With no employer to withhold taxes on your behalf, it’s important to keep on top of it yourself. Set up automatic deductions each month to ensure you’re able to make estimated quarterly payments. 

How to manage self-employment income

With vendors to pay and invoices to chase up on, you might be wondering how to manage self-employment income more effectively. Here are a few tips to streamline your accounting processes.

1. Separate personal and business finances.

Set up separate accounts for your business and personal expenses. This makes it easier to track and manage your finances for accounting purposes.

2. Pay yourself self-employment income according to market rates.

It’s tempting to boost cash flow by paying yourself a lower salary, but you should stick to market rates to keep finances in balance. Don’t undercut yourself by charging clients too little; in the end you’ll end up having to raise prices to make ends meet.

3. Create a realistic budget.

Put an accounting system in place to track incoming and outgoing payments. Prepare for upcoming expenses with a realistic budget and accompanying balance sheet to track assets, liabilities, and equity. Run a cost-benefit analysis to help with financial decision-making.

4. Clearly outline your payment expectations.

Timely payments go a long way when it comes to improving your cash flow. Provide clear payment expectations on each invoice you send to clients, including payment terms and due dates. Accepting a wide range of online payments makes it easier for customers to pay you quickly and easily. It’s also a good idea to send out automated reminders to prevent late payments.

GoCardless invoicing is ideal for managing self-employment income, allowing you to get paid automatically via bank debit on the due date. You’ll avoid the stress of late payments, for a more predictable self-employment cash flow.

We can help

GoCardless helps you automate payment collection, cutting down on the amount of admin your team needs to deal with when chasing invoices. Find out how GoCardless can help you with ad hoc payments or recurring payments.