Tax
Help for Small Business Owners
...and the Self-Employed
Small Business
Tax Issues for Self-Employed Individuals
The United States
is a nation of entrepreneurs. There are literally tens of millions of
self-employed individuals
that enjoy pursuing their dream business. Of course, few of you enjoy
the paperwork and confusing tax issues that arise
from owning your own business.
Many
self-employed individuals are considered "sole proprietors" or
"independent contractors" for legal and tax
purposes. This is true regardless of whether you are turning a hobby
into a business, selling an indispensable widget or
providing services to others. As a self-employed person, you report
business revenue results on your personal income tax
return. Following are a few guidelines and issues you should keep in
mind if you are pursuing your entrepreneurial
spirit.
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Schedule C - Form 1040
As
a self-employed person, you are required to report your business
profits or losses on Schedule C of Form 1040.
The income earned through your business is taxable to you as an
individual. This is true even if you do not withdraw any
money from the business. While you are required to report your gross
revenues, you are also allowed to deduct business
expenses incurred in generating that revenue. If your business efforts
result in a loss, the loss will generally be
deductible against your total income from all sources, subject to
special rules relating to whether your business is
considered a hobby and whether you have anything "at risk."
Home-Based Business
Many
self-employed individuals work out of their home and are entitled to
deduct a percentage of certain home
costs that are applicable to the portion of the home that is used as
your office. This can include payments for utilities,
telephone services, etc. You may also be eligible to claim these
deductions if you perform administrative tasks from your
home or store inventory there. If you work out of your home and have an
additional office at another location, you also may
be able to convert your commuting expenses between the two locations
into deductible transportation expenses. Since most
self-employed individuals find themselves working more than the
traditional 40-hour week, there are a significant number of
advantageous deductions that can be claimed. Unfortunately, we find
that most self-employed individuals miss these
deductions because they are unaware of them.
Self-Employment Taxes - The Bad News
A
negative aspect to being self-employed is the self-employment tax. All
salaried individuals are subject to
automatic deductions from their paycheck including FICA, etc. In that
many self-employed individuals often do not run a
formal payroll for themselves, the government must recapture these
taxes through the self-employment tax. Simply put, you
are required to pay self-employment taxes at a rate of 15.3% on your
net earnings up to $87,900 for 2004. For net income in
excess of $87,900, you will pay further taxes at a rate of 2.9% on the
excess.
In
an interesting twist that reveals the confusing nature of the tax code,
you are allowed a partial deduction for
the self-employment tax. Simply put, you are allowed to deduct one-half
of your self-employment taxes from your gross
income. For example, if you pay $10,000 in self-employment taxes, you
are allowed a deduction on your 1040 return of
$5,000. Many self-employed individuals miss this deduction and pay more
money to taxes than needed.
Health Insurance Deduction
This
used to be a very messy area for self-employed individuals, to wit, you
received little tax relief when it
came to your health insurance bill. This was a particular burden for
small business owners when considering the
astronomical cost of health insurance. All of this has changed and you
now may deduct 100% of your health insurance costs
as a business expense.
No Withholding Tax
Unlike
a salaried employee sitting in a cubicle, you are not subject to
withholding tax on your paycheck. While
this sounds great, you are required to make quarterly estimated tax
payments. If you fail to make the payments, you are
subject to a penalty, but the penalty is not the biggest concern.
A
potential and dangerous pitfall of being self-employed is failing to
pay quarterly estimated taxes and then
getting caught at the end of the year without sufficient funds to pay
your taxes. The IRS is not going to be happy if you
fail to pay your taxes and you will suffer the consequences in the form
of penalties and interest. Making sure you pay
quarterly estimated taxes helps avoid this situation and it is highly
recommended that you follow this course of
action.
Record Keeping
You
must maintain complete records of all business income and expenses.
Simply put, document everything. Create a
filing system for each month and file every receipt, etc. All business
travel expenses must be documented, including auto
mileage you incur when performing business tasks. Office supply stores
sell business mileage books that you can keep in
your car and use whenever you travel. If you have any doubt about
documenting something, just do it!
In Closing
As
a self-employed individual, your focus and time is spent on making your
business successful. Your focus is not
on the complexities of the tax code and how to limit the amount of
taxes you owe. If any of the information in this article
is new to you, then it is highly likely you have paid far more in taxes
than required.
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