How to File Taxes When You Work for Yourself

Tax time is hectic for most Americans -- there's nothing like the government taking a close look at your finances to elevate your stress level.

This is especially true if you are one of the 21.5 million Americans who file as sole proprietors or self-employed taxpayers.

Pursuing your entrepreneurial dreams has drawbacks at tax time -- including extra forms, estimated tax payments and a higher tax rate (on top of federal and state taxes, and the normal Medicare and Social Security contributions, self-employed taxpayers get hit with an additional 7.65% tax). But sole proprietors are also eligible for a number of deductions that aren't available to regular employees.

Need a little help to wade through the red tape? Here are some guidelines:

Look for Help

If this is your first time filing as a self-employed taxpayer, you might not want to tackle it alone. "If you have a significant change in your tax situation, it might be a good idea to hire a professional," says Keith Hall, a CPA and tax expert with the National Association of the Self Employed. "You can then use your 2007 return as a template for what forms to fill out and what deductions to look for on future returns."

At the very least, use online tax software such as TurboTax or TaxACT 2007. "Math errors are the number one reason that people get a reply from the IRS," says Hall. "Transposing numbers in a Social Security number or making a mistake when transferring totals from one form to another is easy to do. The software is designed to take care of that, and to check the math."

What You Need

Whether you hire a professional or do it yourself, you'll need to gather the following information:

• All of the paperwork documenting your business income: typically sales receipts or, in the case of contract work, 1099-MISCs. (The moment you fill out a Schedule C, for business profit or loss, you increase your likelihood of getting audited. So make sure you have the backup documents.)

• Any income you received as an employee, documented on W2s.

• Documentation of any other income, such as dividends or interest from investments.

• A list of business expenses including travel, equipment purchases, contract expenses and association fees, along with receipts and other documentation needed to support each claim.

• Documentation of personal deductions such as mortgage interest payments, health insurance premiums, student loan interest payments and so on.

If you have trouble finding the necessary paperwork, take it as a sign that you need to develop better systems for organizing your 2008 tax records.

Consider an Extension

If April 15 looms and you're not ready, you can e-file for an automatic six-month extension using Form 4868. While the extension gives you time to do your paperwork correctly, it doesn't let you postpone your payment -- you still have to pay the IRS by April 15 or pay penalties and interest.

You should have at least a rough idea of your revenues and major expenses, so you can base your April 15 payment on those numbers. You can then use the extra six months to gather the necessary information and fine-tune the numbers on your return. If you overpay in April, you can get a refund when you file in October. But if you underpay in April, you may owe interest on the difference.

Use All Business Deductions

One of the biggest differences between filing as a self-employed person and filing as a regular employee is your overall tax liability: You're likely to owe more when you're self-employed than you would as an employee, because you must pay FICA (Social Security and Medicare) taxes as both employer and employee.