Small Business Tax Issues for Self-Employed Individuals
by Richard A. Chapo
The United States is a nation of entrepreneurs. There are literally tens of millions of self-employed
individuals that enjoy pursuing their dream business. Of course, few of you enjoy the paperwork and
confusing tax issues that arise from owning your own business.
Many self-employed individuals are considered "sole proprietors" or "independent contractors" for
legal and tax purposes. This is true regardless of whether you are turning a hobby into a business,
selling an indispensable widget or providing services to others. As a self-employed person, you report
business revenue results on your personal income tax return. Following are a few guidelines and issues
you should keep in mind if you are pursuing your entrepreneurial spirit.
Schedule C - Form 1040
As a self-employed person, you are required to report your business profits or losses on Schedule C
of Form 1040. The income earned through your business is taxable to you as an individual. This is
true even if you do not withdraw any money from the business. While you are required to report your
gross revenues, you are also allowed to deduct business expenses incurred in generating that revenue.
If your business efforts result in a loss, the loss will generally be deductible against your total
income from all sources, subject to special rules relating to whether your business is considered a
hobby and whether you have anything "at risk."
Home-Based Business
Many self-employed individuals work out of their home and are entitled to deduct a percentage of
certain home costs that are applicable to the portion of the home that is used as your office. This
can include payments for utilities, telephone services, etc. You may also be eligible to claim these
deductions if you perform administrative tasks from your home or store inventory there. If you work
out of your home and have an additional office at another location, you also may be able to convert
your commuting expenses between the two locations into deductible transportation expenses.
Since most self-employed individuals find themselves working more than the traditional 40-hour
week, there are a significant number of advantageous deductions that can be claimed. Unfortunately,
we find that most self-employed individuals miss these deductions because they are unaware of them.
Self-Employment Taxes - The Bad News
A negative aspect to being self-employed is the self-employment tax. All salaried individuals are
subject to automatic deductions from their paycheck including FICA, etc. In that many self-employed
individuals often do not run a formal payroll for themselves, the government must recapture these
taxes through the self-employment tax. Simply put, you are required to pay self-employment taxes at
a rate of 15.3 percent on your net earnings up to $87,900 for 2004. For net income in excess of $87,900,
you will pay further taxes at a rate of 2.9 percent on the excess.
In an interesting twist that reveals the confusing nature of the tax code, you are allowed a partial
deduction for the self-employment tax. Simply put, you are allowed to deduct one-half of your
self-employment taxes from your gross income. For example, if you pay $10,000 in self-employment taxes,
you are allowed a deduction on your 1040 return of $5,000. Many self-employed individuals miss this
deduction and pay more money to taxes than needed.
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