If You’re Self-Employed, Don’t Fall Into a Tax Trap
Are you self-employed or considering becoming self-employed? If so, you need to pay special attention to the unique tax issues you’ll face. Whereas employees have Social Security, Medicare, and income taxes automatically withheld from their paychecks, as a self-employed individual you need to develop a system to track and deposit those taxes, which can easily total 35% or more of your net income. (Fortunately, there may also be a number of business expense deductions you can claim to lower your net income.)
Self-employed individuals run into tax problems for two primary reasons: poor record keeping and/or failure to set aside and pay self-employment taxes. I usually recommend one of the following options to my clients to head off tax problems before they can occur:
· Structure Your Business as an S Corporation. For profitable businesses, an S corporation election may minimize your total taxes. Dividends from S corporations are exempt from payroll and self-employment taxes as long as the business pays you a reasonable salary. You should consult a tax professional for advice on the proper structure for your business.
· Put Yourself on Payroll. For some individuals, the best option is to pay yourself a salary as an employee of your business. That can ensure that all taxes are withheld from your pay and timely deposited to the proper tax authorities.
· Set Aside Taxes in a Separate Bank Account. Another option is to calculate your taxes on a monthly or quarterly basis and set the money aside in a separate savings account where you won’t be tempted to spend it. Some clients, particular owners of S corporations, like to pay themselves one salary check in December that covers the entire year’s tax obligations (the taxes are paid as wage withholding on the paycheck). Doing so avoids tax penalties and allows you to earn interest on the money during the year.
· Pay Quarterly Estimated Taxes. If you do not pay your taxes by wage withholding, the IRS requires that you deposit 25% of your estimated taxes for the year on April 15, July 15, October 15, and January 15. Proper calculation of the estimated taxes is essential to avoid underpayment (which could lead to IRS and South Carolina penalties) or overpayment (which would reduce your working capital).
From structuring your business, to choosing the best retirement plan, to calculating and paying your taxes, the tax obligations associated with self-employment can quickly become overwhelming. Your best bet is to consult a tax professional for assistance. He or she can take the tax burden off of you and allow you to focus on what you do best: managing and growing your business.
Mark C. Neath, is a Daniel Island resident and partner of Accel Tax & Business Services, LLC, which specializes in individual and business tax services, bookkeeping and consulting, business valuations, and financial planning. He can be reached at 843-763-7909 or mneath@bellsouth.net.
