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Beware the Taxes of Self-Employment

You can be self-employed as a sole proprietor, independent contractor, or member of a partnership or limited liability company. As such, you need to file an annual income tax return and pay estimated taxes throughout the year on your income. Also, you may have to remit self-employment (SE) tax payments as well with your estimated income tax payments. The SE tax is a Social Security and Medicare tax — being self-employed, you have to pay both the employer and employee portions.

The self-employment tax is 15.3 percent of your net earnings. As an employee, you and your employer split the burden, each paying half. This is why your first reaction to the SE tax may be dismay.  The SE tax tends to sneak up on new business owners, especially if they’ve become profitable quickly.  If the owner doesn’t make payments in during the year, the SE Tax can help create a bill for tens of thousands of dollars, all due by April 15th.

To pay the income tax and self-employment tax liabilities, you may be required to make quarterly estimated tax payments. Typically, the quarterly payments are due April 15, July 15, Sept. 15 and Jan. 15. Quarterly estimated tax payments can be made using Form 1040-ES, Estimated Tax for Individuals. The taxpayer may elect to pay electronically through the Electronic Federal Tax Payment System. If this is your first year being self-employed, you will need to estimate the amount of income you expect to earn for the year.

If you earned a living as an employee, your taxes would be withheld every time you were payed by your employer.  For the self-employed, the IRS wants to receive the tax owed at least quarterly, in any quarter where there were earnings.  You can always make estimated tax payments more frequently though, which we often recommend.  It helps with budgeting and expense management to pay the bill in smaller and more consistent amounts.

If your net earnings from self-employment exceed $400 or more, you will be required to file a personal income tax return with a calculation for your self-employment taxes on Schedule SE. Net earnings are generally calculated by starting with gross income from the business and subtracting deductions and depreciation allowances.

Generally, you’ll have to file a Schedule C or Schedule C-EZ to report your income or loss from a business you operated or a profession you practiced as a sole proprietor. If your expenses add up to $5,000 or less, you can file Schedule C-EZ instead of Schedule C.

You may operate as a married couples business — a qualified joint venture — and though you file a joint return, you can elect not to be treated as a partnership for federal tax purposes. You each can calculate your self-employment taxes separately, as well as account for your respective share on Schedule C. There may or may not be advantages to doing this, so again, consult with a professional before making a decision.

For more help, consult the IRS’s “Small Business Taxes: The Virtual Workshop,” an online learning tool with nine interactive lessons designed to help you understand your tax rights and responsibilities. The IRS Video Portal contains video and audio presentations on topics of interest.

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