Self-Employment Taxation - The Basics
By Peter Jason Riley
Income from self-employment is subject to two levels of taxation
- The first is the 15.3% self-employment tax. This tax has 2 elements: 2.9%
is Medicare tax and 12.40% is Social Security taxes the I.R.S. collects on behalf
of the Administration. Social Security tax is only applied on
the first $102K in 2008 and $106,800 in 2009. Medicare tax is calculated on all the self-employment
income. It is important to remember that your personal exemptions and deductions
for your home interest, real estate tax, and state taxes, etc. do not effect
the calculation of this tax.
- The second is, of course, federal income tax.
Other issues to be considered:
- In 2008 You will be allowed to deduct 100% of your health insurance costs
as a trade or business expense.
- Your income will not 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.
- 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 of their deductibility and require special attention.
- 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
- You should consider establishing a retirement plan. The advantage of a retirement plan is that amounts contributed to the plan are deductible at the time of the contribution, and are not taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee plan (SEP) or a SIMPLE plan, which requires less paperwork. If you do not establish a qualified retirement plan, you may make a contribution to an IRA.
One last matter of concern for self-employed individuals is the high rate of Internal Revenue Service audit – 1.91% of all schedule C filers is audited in 2003; nearly triple the rate for other taxpayers. Small proprietors received the most attention – 3% of those with total gross receipts of less then $25K were examined.
Remember, this is a very simple outline of the basic tax matters involved in self-employment income. It is not meant to be the complete story!