Taxes are not optional, simple or forgiving if you are self-employed. If you do not do your taxes correctly, the government will let you know it quickly. However, if you do them correctly, you will keep more of your earnings and not be on the IRS radar. That’s the goal.
Profit Is More Important Than Sales
Many individuals are overwhelmed with how much money is coming in, which is a common misconception. The bottom line for taxes is not how much money comes in; it is how much you actually have after expenses. It is possible to earn a large sum of money, but depending on how much you spent, you may pay less tax than someone who earned less but did not spend any money.
The distinction between gross and net income will become a valuable resource for you.
Let us say you sell homemade cookies for events. You receive $100 for your cookies – fantastic! However, you must keep in mind the cost of the ingredients, packaging, gas and tools. All of these costs add up to $30.
Your actual income is now only $70. The government is only concerned with this $70. The more legitimate expenses you can track, the lower this number becomes, and this is a positive for you.
Expenses Are Not The Enemy
People often feel guilty about taking expenses. They shouldn’t. Tax-deductible expenses will decrease your taxable profit, which means that you will owe less tax because taxable profit determines how much tax you’ll pay.
Things like mileage, supplies, tools, software, packaging materials, small upgrades, etc. will qualify if it is used for work purposes.
A lower taxable profit on paper will equal a lower tax payment in real life.
When you are self-employed, you don’t have one tax; you have multiple taxes, some of which are obvious and some that sneak up on you.
Federal Income Tax- The Big Dog
This tax works the same way as it does for employees; however, no one is withholding it for you. Your profit will dictate your rate, based on how much profit you made. The tax is a progressive tax system with the highest percentage on your first dollar of profit.
Self Employment Tax: The Whale Everyone Bitches About
This tax is the money that funds Medicare and Social Security. If you have ever worked for a company, you’ve already been paying for part of this tax without knowing it.
Now, instead of having only half of the amount paid, you are paying double, the total rate is 15.3% of your net income.
It seems like a lot of money, but it basically takes the place of what the employer provided for you.
Seeing Tax Payments Actually Hurt
When you were employed by someone else, your employer would have paid half of the social security benefits and the employee would not see the matching contribution because the employer was the one holding onto those funds.
State
While there are some states such as Florida that do not collect state income tax there are other states that collect more than the state of Florida.
Sales Taxes
You may sell a product and need to collect sales tax from your customers. Although you have collected sales tax and are maintaining it for the state you do not have to pay that money to the state until you file your business tax return.
The sales tax would only need to be collected based on what you sell and the location of your business.
City & State Fees and Licenses
This is where many people fail. Many states and cities require businesses to be registered and pay local fees, whether you have a brick-and-mortar store or will run a business out of your home.
You may also be liable for local taxes on your inventories and tools used at work.
If you think that ignoring these local fee and licensing requirements will make them go away, you are sadly mistaken. Not only will you end up paying much more for it later if you ignore it, you could even lose your business altogether.
A great majority of self-employed people fail to find out about their local fee and licensing requirements until they receive a fine for non-compliance. With just a few minutes on the phone or in an email to your local licensing offices, you can potentially save hundreds of dollars and a ton of stress.
Tracking self-employment taxes is not impossible, but does require some focus and persistence. Make sure to keep careful records of all sources of income. You should keep very aggressive records of all applicable expenses, but be honest about all expenses. Be aware of what taxes apply to you based on your current location and business type.
By being proactive with your self-employment taxes, it becomes much easier to manage. By ignoring your taxes and not paying attention to them, they can bite you back!
Being your own boss is an incredible opportunity, but don’t forget that you also need to manage your own payroll!
