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Taxes for the Self-Employed

Business Entity Structure / Business Finances / Save on Your Taxes

Going into business for yourself means learning about a lot of things, and not all of them are necessarily fun.  Take taxes, for example.  Unless you’re an accountant, dealing with the tax issues that come with your business is probably not your favorite task.  But once you get the hang of it, it really isn’t so bad.

First Up: Are You Self-Employed?

The threshold issue you need to determine is whether you are considered self-employed and therefore subject to federal government self-employment taxes.  If you are in business for yourself to make money, even in a part-time venture, you are generally considered self-employed.  This is the case if you work as a sole proprietor, an independent contractor, or as a partner in a business.

Next: What Do You Have to Pay?

The biggest change for those of you who  are newly self-employed is that most of you have to begin paying self-employment taxes.  These taxes consist of Social Security and the Medicare tax.  Other taxes may apply, depending upon whether you have employees and the nature of your business.

If your net earnings are $400 or greater, you must file an income tax return.  To determine your net earnings, compare your income and expenses.  The result is reported on the first page of your individual tax return, either as part of your income or as a loss.

When you work as an employee for someone else, your employer has to pay these taxes for you.  When you go into business for yourself, you have to pick up the tab that would normally be paid for by your employer.

The good news is that contributing to Social Security earns you points in the Social Security system.  When you retire or if you become disabled, you will have contributed money to Social Security, from which you then can receive benefits.  You can check your Social Security contributions and estimate your benefits online.

Can You Pay Less?

One of the best parts of being self-employed is that you can structure your employment of yourself to be most tax-advantaged.

If you incorporate your business as an LLC taxed as an S-corporation (rather than as a sole proprietorship or a partnership), you will only pay the self-employment taxes on the salary you pay yourself as a W-2 employee of the business.

If you take distributions on top of your salary, you will only pay income tax and avoid the self-employment tax. So pay yourself the lowest salary you can and still have it be reasonable, as it must be reasonable, so you can minimize the self-employment taxes you pay. Take the rest out as distributions.

Be sure to contact us if you want more guidance on this because it can get complicated.

Finally: When Do You Put up the Dough?

The Federal tax system is a pay-as-you-go system.  That means that as you earn income, you must pay applicable tax on it.  When you are self-employed, you have no employer to pay your taxes for you, so you must submit them regularly yourself.

The Internal Revenue Service has long used a system of quarterly estimated tax payments to facilitate its pay-as-you-go system.  Under this system, you submit estimated tax payments four times each year, at the end of January, April, July, and October.

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