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This nation is composed of literally millions of individuals who are pursuing their dreams of self-employment. As a matter of fact, over 99% of all business entities are small, individually-owned enterprises. And, although running a business has numerous personal and financial rewards, managing the obligatory tax issues of self-employment is probably not one of them. They are, however, a necessary part of any and every business, be it large or small. Let’s examine some of the issues that are of particular concern to the self-employed.
Many self-employed business owners are set up as sole proprietors for legal and tax purposes. Under this classification of ownership, all business revenue is reported on the owner’s personal income tax return. Profits and losses are recorded on Schedule C of Tax Form 1040. The income of a sole proprietor is taxable as personal income, even if money is not withdrawn directly from the business. And while gross revenues must be reported, qualified business expenses which are incurred while generating that revenue is allowed to be deducted. In addition, if the business loses money for the year, the loss can generally be used as an offset of total personal income from all sources.
Many self-employed individuals work from their homes and, as such, are eligible to deduct a portion of their housing costs as business expenses. The deductible amount is limited to the percentage of the home or services that are used specifically for the business. For instance, if an individual has a 2,000 square-foot home and uses the 500 square-foot den as an office, then one-fourth of the mortgage payment may be deducted as a business expense as long as that area is used only for business purposes. Utilities, telephone and internet services, and other expenses may also be deducted. If administrative tasks or storage of inventory is done at home, these deductions may still apply. Also, commuting between two places of work may be converted to deductible travel expenses. If a business owner has an office at his or her home and another office at an additional location, then normal travel between the two is deductible.
Health insurance has historically been rather expensive for self-employed individuals. This is because, without a traditional employer to help defray the premium costs, the business owner is left to bear the entire expense alone. Previously, there was little relief for the costs of health care; recent changes in the tax code, however, have now made it possible to deduct 100% of health insurance costs as a business expense.
Unlike salaried employees, self-employed individuals are not subject to normal payroll withholding. They are therefore required by the IRS to make quarterly estimated tax payments. Neglecting to make these payments could expose the small-business owner to penalties and interest charges, as well leaving him or her liable for a possibly quite sizeable year-end tax bill. Paying the quarterly estimated taxes largely reduces this risk.
Additionally, salaried employees pay Social Security and Medicare taxes as a course of automatic deduction. Individuals in business for themselves are required to pay self-employment taxes at the rate of 15.3% on wages, tips, and net earnings up to $94,200; any income above that amount is subject to a 2.9% taxation rate. One-half of the total self-employment tax is, however, deductible from the individual’s gross income.
