When most small business owners think about taxes, they think about Federal income taxes. But there are other taxes that I want to let you know about, so you’re not surprised if you have to pay them.
The first is self-employment tax. If you’ve ever worked for someone else, you know that social security and Medicare taxes get deducted from your paycheck. When you’re self-employed, you don’t actually get a paycheck.
Here’s what happens if you’re a sole proprietor. Following the IRS rules and regulations for calculating income and expense, you report your results for the year on your personal 1040 by filling out Schedule C.
Then you take the net profit and put it on Schedule SE for self-employment tax. After a small deduction, you calculate 15.3 % as your self-employment tax. This is double the rate of 7.65 % that’s deducted from employee paychecks because as a sole proprietor you’re both the employer and the employee so you have to pay both parts.
You get to take half of the amount of self employment tax as a deduction from your income on the front of your 1040. This has the effect of reducing your taxable income.
The self employment tax itself goes on the back of the 1040 in the section called Other Taxes on the line that says self employment tax. For the 2006 filing year that was line 58. This tax gets added to your Federal income tax and any other taxes you owe and is paid when you file your 1040.
If you (and/or your spouse on a joint return) have had Federal income tax withheld during the year that adds up to more than your total taxes for the year (which includes self employment tax), you’ll still qualify for a refund.
If your business is operated as a corporation AND you’re active in your business, you should receive W-2 wages and you won’t be subject to self employment tax on your earnings. Distributions from S corporations are generally not subject to self employment taxes.
If your business is operated as a partnership, you might have some items of income that are subject to self employment tax and some that are not. These items will be reported to you on a schedule K-1 that is part of the business tax return.
Sales tax
Many States have sales taxes. If you sell products to customers, you’ll have to charge them sales tax and pay it to the State. In some cases, digital downloads are considered products as far as the sales tax rules are concerned and certain services might also subject to sales tax. In Indiana, where I live, the rules are put out by the Indiana Department of Revenue. There will be a similar agency in your state who you can contact to find out the rules.
Local Taxes
Some cities and school districts have local taxes that you might have to pay. Some of these depend on your type of business. There might be additional sales taxes, property taxes, innkeeper’s taxes, or food and beverage taxes. Check with the authorities in your area for details.
And then there’s the often dreaded Estimated Taxes
This is a subject that confuses many people.
First, let’s try to understand the reason that the estimated payment system exists. Our system of Federal taxes is a “pay as you go” system. When you think about it, that makes sense. The government needs money all year long to pay for various things.
When you work for someone else, taxes are withheld from your paycheck each pay period, so the government gets its money over the course of the year. If you’re a sole proprietor, this doesn’t happen, so you’re expected to make estimated payments.
As with many IRS rules, there are some exceptions, and some penalties if you don’t pay enough or pay on time. There are some cases where you might not be required to make estimated payments (and you won’t have a penalty if you don’t), but it would still make sense to make them anyway, to avoid having to pay a large amount on April 15th.
If you have another job in addition to your self-employment, you can increase your Federal withholding on that job to cover the amount of the estimated taxes that you would otherwise have to pay. And if you’re married and file a joint return and your spouse has wages from another job, he/she can have additional Federal withholding taken out to cover the estimated payments.
Or, you can make quarterly payments using Form 1040-ES. You can also sign up to make the payments on-line. You might also need to make estimated payments towards your State taxes.
Payroll
If you have employees, you’ll need to pay various Federal, State, and local payroll taxes. But we’ll have to save that conversation for another time.
The most important thing you need to understand is that it’s your responsibility to find out what taxes your business has to pay. And that the laws vary from place to place and by type of business.
A good source of information is an accountant who specializes in consulting with small businesses.
Sheryl Schuff, CPA, is a Certified Public Accountant, author, and consultant who teaches entrepreneurs how to get their businesses organized, keep good accounting records, and maximize their business tax deductions. She is President of Schuff & Associates, PC and has been in private practice for over 30 years. She recently started an information products company www.TaxesForSmallBusiness.com to provide individual training materials for small business owners.