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Tax
Aspects of Self Employment
If you are in business for yourself, as a sole proprietor or plan to go into
business for yourself you should be aware of some of the tax aspects of your
sole proprietorship.
As a sole proprietor, you would report net income or loss from your business
on your personal income tax return. However, there are several important rules
that you should be aware of:
(1) For income tax purposes, you will report your income and expenses
on Schedule C of your Form 1040. The net income will be taxable to you
regardless of whether you withdraw cash from the business. Your business
expenses will be deductible against gross income (i.e., “above the line,”
and not as itemized deductions subject to the 2%-of-adjusted-gross-income floor
or the 3%/80% reduction rules). If you have any losses, the losses will
generally be deductible against your other income, subject to special rules
relating to hobby losses, passive activity losses and losses in activities in
which you weren't “at risk.”
(2) If you will be working from an office in your home, performing
management or administrative tasks from a home office, or storing product
samples or inventory at home, you may be entitled to deduct an allocable portion
of certain of the costs of maintaining your home. And if you have a
home office, you may be able to convert nondeductible commuting expenses (of
going from your residence to another work location) into deductible
transportation expenses.
(3) The Social Security tax rate
for 2010 is 15.3 percent on self-employment income up
to $106800
and at a rate of 2.9% on the excess. (The maximum amount will be
reduced by any non-self-employment wages you earn.) One-half of your
self-employment taxes will be deductible as a trade or business expense (that
is, as a deduction against gross income, not subject to the limits that apply to
itemized deductions).
(4) You will be allowed to deduct 100% of your health insurance costs
as a trade or business expense. This means your deduction for medical
care insurance won't be limited by the normal 7.5%-of-AGI floor on itemized
medical expenses.
(5) Your income won't be subject to withholding tax.
However, you will be required to pay estimated taxes quarterly. We can work with
you to minimize the amount of your estimated tax payments while avoiding any
underpayment penalty.
(6) You will have to maintain complete records of your income and
expenses. In particular, you should pay attention to recording your
expenses in order to be able to take the full amount of the deductions to which
you are entitled. Certain types of expenses, such as automobile, travel,
entertainment, meals, and home office expenses, are subject to special
recordkeeping requirements or limitations on their deductibility and require
special attention.
(7) If you hire any employees, you will have to get a taxpayer
identification number and will have to withhold and pay over various payroll
taxes.
(8) You should consider establishing a qualified retirement plan.
The advantage of a qualified retirement plan is that amounts contributed to the
plan are deductible at the time of the contribution, and aren't taken into
income until the amounts are withdrawn. Because of the complexities of ordinary
qualified retirement plans, you might consider a simplified employee pension
(SEP) plan, which requires less paperwork. Another type of plan available to
sole proprietors that offers tax advantages with fewer restrictions and
administrative requirements than a qualified plan is a “savings incentive
match plan for employees,” i.e., a SIMPLE plan. If you don't establish a
retirement plan, you may still be able to make a contribution to an IRA.
If you would like any additional information regarding the tax aspects of
your going into business, or if you need assistance in satisfying any of the
reporting or recordkeeping requirements, please give me a call.
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