Volume 3 Issue 2008

If you are, then having the freedom to be your own boss is probably one of the things you like most about the idea of going into business for yourself. One of the things you may like least is the idea of having to pay taxes on your profits. But when you are just starting out as a self-employed individual, you need to know how your business income will be taxed so that you can take advantage of any available opportunities to reduce your tax bill.

Federal Income Tax

Like many of the self-employed, you may decide to operate your business as a sole proprietor. In that case, you’ll be required to report your business income and expenses on a special form (Schedule C) attached to your personal income-tax return. Your net profit from the business (if any) will be included with your other sources of income and taxed at your individual income-tax rate. Note that you also can use a Schedule C for reporting purposes if you decide to form a single-owner limited liability company (LLC) instead of operating a sole proprietorship.

Self-employment Tax

When you’re just starting out, the self-employment (SE) tax can take you by surprise. It basically serves as a substitute for the Social Security and Medicare (FICA) taxes paid by employees and their employers. If you earn at least $400 from your business, you’ll be responsible for paying SE taxes on your earnings.

The SE tax rate is 15.3% — 12.4% for Social Security (on up to $102,000 of earnings in 2008) and 2.9% for Medicare (no earnings ceiling). These rates are essentially double what an employee pays through wage withholding because, in an employment situation, the employer pays the other half of the tax. Self-employed individuals may claim a tax deduction for half of the SE taxes they pay.

Paying Estimated Tax

As a self-employed individual, you won’t receive a paycheck and you won’t have to withhold taxes from the money you withdraw from the business for personal use. But the IRS still wants to receive its tax money during the year. So, you’ll typically need to send estimated tax payments to the IRS each quarter to cover the expected tax liability on your earnings. You could be subject to penalties and interest charges if you don’t make adequate estimated tax payments.

Talk with Us

Once you decide to go into business, talk with us about how your business will be set up, the types of expenses that will be deductible, and the records you’ll need to substantiate your income and expenses for tax purposes. We can help you get off to a good start with your new venture.