How Does Taxes work for Self Employed Individuals?

Tax season is here. While people have a brief idea about the financial and tax rules concerning salaried or employed status, only a handful know how taxes work for self employied individual.

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To understand the taxation rules for self-employed businesses, it is essential to understand what it entails. 

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Self-employment is when you work for yourself instead of another employer. You are your own boss. You provide the services to others in return for a fee. 

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For instance, when you are working as a freelancer and offering your services to companies or freelancers, you are self-employed. 

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Similarly, you can proudly call yourself self-employed when you have a business under your name and sell services or products in B2B, B2C, or D2C models. 

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Although it sounds tempting, considering the flexibility and independence in conducting business operations, you cannot ignore how much you have on your plate. 

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From investing in the right areas at the right time to finding ways to save your hard-earned money from taxes and filing Income tax returns – there are so many things to be done. 

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Out of this, taxation seems to be a significant concern. One slip and your business revenues and operations might be at stake.

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So, here’s a guide that tells you everything about taxation for a self-employed individual in India.

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Financial and legal tasks a self-employed individual needs to perform

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Before jumping straight into the taxation system for self-employed individuals, we would like to shed light on the duties they have to bear in the financial and legal concepts.

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This brief will give you more clarity on your responsibilities, ensuring you don't ignore them at any cost.

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1. Once you link your pan card with your registered business, you must file your income annually. However, it doesn't mean you need to pay the taxes from the beginning because, according to the Indian Revenue Services, taxation will be levied after a certain income level.

2. You must maintain a proper balance sheet explaining your assets and the expenses you are liable for. You must also list your profits, losses, and incomes at every step, ensuring all the numbers match correctly. 

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3. You are also responsible for keeping track of every transaction made under your business name. If you are paying a vendor or a freelancer, you make an online or check transaction. Your cash transactions should not be more than ₹20,000.

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When does a self-employed person need to pay tax? 

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As a self-employed individual, you are liable to pay the taxes once your annual income is equal to or greater than ₹2.5 lakhs. The tax to be paid is calculated in two ways:

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1. It can be calculated based on an assumed taxation amount raised when the income does not consider the expense deductions made to generate revenues for the business.

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2. Another way is to calculate tax on the actual profit made, considering the proper expenses the business had to endure to generate the revenues. 

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Presumptive taxation for a self-employed individual

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According to Section 44DA in the Income Tax Act, any individual earning less than ₹50 lakhs in a financial year is liable for the presumptive taxation rule. 

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For a self-employed individual, the minimum income will be 8% of the gross receipts. Based on this income value, you will have to incur tax.

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Auditing the book of accounts

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Any self-employed professional having a gross receipt worth more than ₹50 lakhs needs to get their accounts audited. 

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The audit needs to be performed by an experienced and licensed Chartered Accountant.

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Once the tax audit is done, the individual must submit the same during tax filing. 

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Taxation rates for a self-employed individual

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Considering the self-employed individual is below 60 years of age, the tax rates will vary based on income.

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1. For taxable income under ₹2.5 lakhs, no tax will be levied.

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2. If the income is between ₹2.5 lakhs and ₹5 lakhs, 5% tax will be calculated on the excess income after ₹2.5 lakhs.

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3. For taxable incomes between ₹5 lakhs and ₹10 lakhs, 20% is deducted from additional income after ₹5 lakhs.

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4. In case of taxable incomes equal to or greater than ₹10 lakhs, 5% and 20% tax rates will be applied along with 30% tax on the income exceeding ₹10 lakhs. 

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ITR types for a self-employed individual

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According to the Income Tax Act, the government has issued multiple ITR forms based on employment terms and annual incomes. 

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Therefore, before you file for the tax, you must learn when to use which form. If you are a self-employed individual, you should fill out ITR Form 3 or ITR Form 4. 

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1. If your gross receipt is more than ₹50 lakhs, but you have accepted the terms and conditions of presumptive taxation, you have to file ITR Form 3. 

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2. You should file ITR Form 4 if your gross annual income is less than ₹50 lakhs. 

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3. Choose ITR Form 4S if you are a freelancer and have opted for the Presumptive Method of Taxation.

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How to file an ITR file for income tax?

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Without knowing the correct way of filing ITR as a self-employed individual, one can quickly get stuck in the mayhem of legal disputes. 

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This is why the following section describes the right way to file the ITR without making any mistakes.

1. Log in to the official account for filing the tax online. 

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2. If you are a new user, register yourself with your PAN details, business information, and so on. But if you already have a registered account, log in to it to proceed further.

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3. 'You need to select the type of user from a dropdown. Then, options like an individual, Hindu Undivided Family (HUF), external agency, Chartered Accountants, and several such titles will be there.

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4. Enter the permanent and current addresses and fill the box with a captcha. Once done, enter the submit button.

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5. Now, you must enter personal information like your name, address, mobile number, email ID, pan number, and so on. 

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6. On clicking the continue button, the Pan card number will be verified. If the verification is successful, all the transaction lists will be displayed.

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7. As the last step, you need to activate the account through the link sent to your email. Once done, the ITR file will be filed.

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Read our blog to understand how to file ITR as a freelancer in detail.

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Taxation mistakes you should avoid being self-employed

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1. You should not miss the due dates for filing the tax returns as then you will be charged with a penalty according to the Indian Income Tax Act, Section 271 H. The minimum penalty charged will be ₹10,000, which can go up to ₹1,00,000.

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2. Although Section 139(5) of the Indian Income Tax Act allows people to make corrections in the filed ITR, it is better not to make the mistakes.

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3. If you do not mention the incomes from all sources, you might quickly get into a legal feud.

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Conclusion

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Handling the taxes as a self-employed individual is no walk-in the park.

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First, one needs to keep track of the correct tax filing deadlines to avoid paying the penalty of ₹10,000. 

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Also, choosing the proper ITR form or opting for presumptive taxation is a hassle.

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So, it's crucial to plan the entire taxation process, from listing the income sources to filing the income tax well ahead in time to avoid last-minute mishaps.