Professional Tax Services, Inc.

Tax services, consulting & IRS representation

Income and self employment taxes for small businesses

Posted on | August 7, 2009 | 1 Comment

Small business taxes

 Federal taxes: income and self employment taxes

          Impact on personal income tax.  When you own and operate your own business, in almost all cases [the exception is a C Corporation], the income or (loss) from the business passes through to your individual income tax return (Form 1040).  Business income increases the total taxable income on your individual income tax return while, in most cases, a loss will offset other income, or, if the loss exceeds your income for the year, it can create a Net Operating Loss which can then be carried back or held for future years and used to offset income in those years.

Assuming your business is making a profit (that’s everyone’s objective, right), I highly recommend you do some tax planning and determine your estimated taxes you need to pay the IRS throughout the year.  The IRS expects you to pay taxes as you earn the income.  This is done either through withholding taxes or by paying estimated taxes.  If you don’t pay as you earn and end up owing money when you file, the IRS will penalize you.

For those of you still working for someone else, you are paid a salary or wages and receive a W-2 at the end of the year.  Through that process, you have Social Security, Medicare and income taxes withheld from your pay each pay period.  The company matches the amount of social security and Medicare withheld from your wages.  Combining what is withheld from your paycheck with the company matching, the total amount paid to the IRS is 15.3% of your taxable wages [there is a threshold on Social Security taxes that changes each year].  If, when you are working for someone else, you have had enough income taxes withheld then you will owe no additional taxes when you file your tax return.

          Impact of being self-employed:  As a self-employed business person, you have just become the employee and the employer for the purposes of paying your payroll (self-employment) taxes.  Even though, in most cases, you do not pay yourself wages or issue a W-2, you still must pay the same Social Security, Medicare and income taxes you would if you were working for someone else.  These taxes for the self-employed are called Self Employment Taxes, surprise, surprise.  As a self employed business person you must pay both halves of Social Security and Medicare taxes; the full 15.3% on the net income of the business.  That is paid when you file your individual income tax return, Form 1040, and is in addition to whatever income taxes you owe. 

So, for your tax planning, you must take into consideration what your total income tax will be for the year, based on your projected business income and other income you receive, minus the various deductions you are allowed.  As a self employed business owner, there is a new deduction you can take; ½ of the Social Security and Medicare taxes you pay can be taken as an above the line deduction in the Adjustments portion of your Form 1040.  To your income taxes you project you will owe, you need to add Social Security and Medicare (that 15.3% I just talked about) to determine your total tax liability.  Assuming your income is earned evenly during the year and also assuming you are not having taxes withheld by an employer, you will divide your tax liability by 4 and pay estimated taxes each quarter.  Estimated taxes are due April 15th, June 15th, Sept 15th and Jan 15th of the following year.  You will use Form 1040-ES to pay your estimated taxes.

If you are working for someone else while you start your business, not a bad idea, by the way, you need to account for the income taxes withheld from your salary or wages to determine what you should be paying in estimated taxes. 

I highly recommend you set up a second business bank account, or use the savings account portion of the account you already have open to set aside money for tax payments.  Your tax planning will tell you what percentage of your business income should be set aside for income and self-employment taxes.  Do not take the money out of the account until all taxes are paid.  Remember, you will not know the full impact of taxes until you file your annual tax returns in the following year. 

In a future blog I will discuss payroll taxes when you have employees.

                        I love doing what everyone else hates to do

Comments

One Response to “Income and self employment taxes for small businesses”

  1. ostrov
    December 2nd, 2009 @ 9:03 pm

    Thank you,
    very interesting article

Leave a Reply





About

As an Enrolled Agent and consummate tax professional, Bill provides year-round, affordable tax services for his clients. Bill is experienced in small business start-up and tax planning in addition to a full range of tax return preparation.

Subscribe to our feed

Search