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Income and Self-Employment Tax for Business Owners

08Nov2016

Income and Self-Employment Tax for Business Owners

When you decide to work for yourself, it quickly becomes apparent that having an employer made it incredibly easy to pay your taxes. When you were employed by someone else and received a paycheck, your employer withheld federal, state and local income taxes from your pay. In addition, your employer paid Social Security and Medicare taxes on your behalf. Now that you’re self-employed, you are solely responsible for paying both the employee’s portion (“income tax”) and the employer’s portion (“self-employment” tax) directly to the IRS. So how much should you pay? When do you make the payments? What forms need to be filed? Hopefully, this brief summary will point you in the right direction.

First, it is worth noting that several categories of people are considered self-employed. Anyone who works for someone else as an independent contractor is self-employed. Also, a small business owner that does not file a business income tax return (sole proprietor) is considered self-employed. Other examples include partnership, or limited liability company that is taxed at the individual level (meaning profits and losses of the business “pass through” to the owners who report this information on their personal tax returns).

Paying Taxes

Income Tax.  Self-employed individuals must pay the estimated income tax with the self-employment tax in quarterly payments to the IRS (and pay the appropriate state tax agency, if there is a state income tax) on the 15th of April, June, September, with final payment due by January 15 of the following year. These quarterly estimated taxes may be conveniently paid using Electronic Federal Tax Payment System (EFTPS) or by submitting IRS Form 1040ES by mail. If you do not pay enough estimated tax payments, you may be charged a penalty.
Income Tax. Self-employed individuals must use Form 1040-ES, Estimated Tax for Individuals to estimate the amount of income tax they’ll owe for the year. (Notably, every taxpayer is responsible for accurately estimating his or her tax liability if the amount owed is expected to be $1,000 or more when filing the annual return.)

Self-employment tax. Self-employed individuals are subject to self-employment tax in addition to the federal income tax. The self-employment tax is two times the Social Security and Medicare tax paid by regular employees (because regular employees’ contributions to the tax are matched by their employers). LLC members get the benefit of deducting half of the total amount from their taxable income, which saves a few tax dollars. The income threshold for paying self-employment tax is very low. You must pay the tax if you have $400 or more in net earnings (the amount left over in profit after deducting business expenses) in a year from all full-time or part-time self-employed activity. The IRS sets a limit on the amount of income subject to the Social Security portion of self-employment tax each year. The self-employment tax rate is 15.3% of the first $117,000 of income for 2014 (up from $113,700 in 2013) and 2.9% of everything above that. There is no limit on the Medicare tax portion of self-employment earnings.

S corporations. If the self-employed taxpayer organizes the business as an S-corporation, some of the income may be classified as salary and some as a distribution. The taxpayer will be liable for self-employment taxes on the salary portion of income, and pay ordinary income tax on the distribution portion. A “reasonable” amount of income must be designated as wages, rather than a distribution. Depending on how the income is divided, this could save a substantial amount of self-employment taxes. Taxes on the estimated income are paid quarterly as explained earlier. Self-employment taxes on the salary portion are paid quarterly on the 30th of April, June, September and January using Form 941.

Annual IRS Reporting

It is important for self-employed taxpayers to file the correct forms with the IRS.

Individual Tax Filings

  • Independent contractors, sole proprietors must report all income (profits or losses) on Form 1040, Schedule C and report the amount of self-employment tax due on Schedule SE.
  • LLC members or partners report profit and loss information from Schedule K-1 on Form 1040, with Schedule E attached and reports the amount of self-employment tax due on Schedule SE.

Corporate Filings

  • LLC or partnership must file Form 1065, U.S. Return of Partnership Income, an informational return that the IRS reviews to make sure LLC members and partners are reporting their income correctly and provide each LLC member or partner with a Schedule K-1, which breaks down the share of the profits and losses.
  • US corporations must file Form 1120 income tax return for a C corporation or Form 1120S for an S corporation by the 15th day of the 3rd month after the end of its tax year. For example, if a corporation adopts a calendar year the returns will be due on March 15th.

Clearly, this is a very general, brief introduction to self-employment tax. The law surrounding payment of taxes by the self-employed is complicated, and each taxpayer’s case is different. To make sure you are paying the right type and amount of taxes, feel free to contact Global Law PLLC to speak with an experienced tax attorney.

by: Suzette Blackwell Esq.

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  • 8 Nov, 2016
  • suzette blackwell
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