It is estimated that the self-employed represent 8%-12% of the working population. They are individuals who identify themselves as self-employed in their own business even if the business is not incorporated. Some descriptions you may have heard are sole proprietors, independent contractors, or perhaps statutory employee.
Statutory employees are often seen in the insurance industry. This type of self-employment has the benefit of having a company pay Medicare and FICA taxes, and the employee receives a W-2. Expenses are split between the individual’s Schedule C and their W-2.
There are also single-member limited liability companies, which are popular for the legal protection it affords. The single-member LLC is a disregarded entity, so income is reported on your own return. No separate return for the entity is required.
So there are many choices with regard to setting up shop to become self-employed, depending on the legal advantages as well as tax advantages. Self-employment can also include work in addition to your full-time business activities, such as, part-time work you do at home or in addition to your regular job.
If you are self-employed, you generally must pay self-employment tax, as well as income tax. It is similar to the Social Security and Medicare taxes withheld from the paycheck of most wage earners. However, the self-employed are considered both the employer and the employee. For 2011, the self-employment tax was reduced from 15.3% to 13.3%. This continues for 2012 with the recent extension of the reduced FICA rate. Self-employment tax is computed using Form 1040 schedule SE.
Self-employed income is disclosed on IRS Form Schedule C, Profit or Loss from Business, which is part of your own Form 1040, so administratively it is one tax return for the year.
If you are self-employed, you may have to make estimated tax payments. Estimated tax is the method used to pay tax on income that is not subject to withholding. If you fail to make quarterly payments, you may be penalized for underpayment of taxes at the end of the year.
If you and your spouse each materially participate as the only members of a jointly owned and operated business, you may make an election to be treated as a qualified joint venture instead of a partnership. By making this election, you avoid the complexity of filing a partnership return, but still give each spouse credit for social security earnings. Planning for retirement also gets easier as earned income is the defining factor in being able to contribute to most types of retirement plans.
As a self-employed individual, you can fund one of the many individual retirement savings accounts. This may also be in addition to a company-sponsored retirement plan you have available at your full time job where you receive a W-2.
Some clients ask us when starting a business, “What costs can I deduct?” They answer is the costs of running a business, known as business expenses. These are the costs you do not have to capitalize or include in the cost of goods sold, but can deduct in the current year. To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that is common and accepted in your business field. A necessary expense is one that is helpful and appropriate for your business. An expense does not have to be indispensable to be considered necessary.
Another question that is asked frequently is, “Do I have to apply for federal Tax Identification Number (TIN)?” The answer is, typically, yes for three reasons. It affords privacy, as a TIN will be used and not one’s Social Security number. It is also used if the business ever has to pay wages to one or more employees. Lastly, it is used if you ever need to file pension or excise tax returns.
At Henssler Financial we believe you should Live Ready, which includes understanding the tax consequences of going into business for yourself. If you have questions regarding your self-employment tax planning, the tax experts at Henssler Financial will be glad to help. You may call us at 770-429-9166 or e-mail at experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
