What Small Business Owners Need to Know About Self-Employment and Income Taxes

 Posted on December 31, 2022 in Small Business Taxes

If you are a small business owner, you may be aware that there are multiple different types of taxes that you need to pay. Self-employment taxes are the combined Social Security and Medicare taxes that sole proprietors, independent contractors, and other types of business owners must pay. Understanding the self-employment taxes that may apply to you can help you make sure you stay compliant with the law and will not be required to pay penalties or fees. 

Understanding Self-Employment Tax

You will generally be required to pay the self-employment tax (also known as SE tax) if you have net earnings of at least $400 from self-employment in a tax year. The SE tax rate is currently 15.3 percent, which consists of 12.4 percent for Social Security taxes and 2.9 percent for Medicare taxes. In 2022, the Social Security portion of the self-employment tax will apply to the first $147,000 of your net earnings, including wages or tips. All combined earnings will be subject to the Medicare portion of the self-employment tax.

Self-Employment Tax Vs. Income Taxes 

In addition to paying SE tax, small business owners also have the obligation of paying income taxes. These taxes will apply to the salary you pay yourself through your business. For businesses that are classified as pass-through entities, including S corporations or LLCs, the profits earned by the business will be "passed through" to the owner, and they will be subject to income taxes. If your business is a sole proprietorship, it will not be separate from the salary you pay yourself, and you will be required to pay income taxes on all business earnings.

Paying Self-Employment Taxes 

It is important to ensure that self-employment taxes are paid on time and in full. Most of the time, small business owners will be required to pay estimated taxes on a quarterly basis. These estimated tax payments include both income taxes and self-employment taxes, and you will typically be required to make these payments if you expect that you will owe at least $1,000 in taxes when you file your annual tax return. Your estimated tax will be based on the adjusted gross income you expect to earn during the year, and deductions and credits may also be figured into this amount. You may be subject to penalties if you fail to pay estimated tax by the due date for each payment period or if you underpay taxes. However if you have paid at least 90 percent of the taxes owed during the current year or 100 percent of the taxes shown on your tax return for the previous year, you will usually not be required to pay a penalty for underpayment.

Tax Deductions 

As a small business owner, you may be able to reduce your overall tax burden by taking advantage of available deductions for expenses incurred in running your business. These deductions may address advertising costs, employee wages, travel expenses, office supplies, and more. Generally, most ordinary and necessary expenses that are related directly or indirectly to running and managing your business can qualify as a deduction. It is important to make sure all deductions are properly documented so that they can be easily identified and calculated when paying estimated taxes and filing tax returns.

Contact Our San Jose Small Business Tax Lawyer

Understanding self-employment taxes is essential for any small business owner who wants to remain compliant with federal regulations while keeping their business profitable at the same time. By familiarizing yourself with SE and income tax requirements, figuring out how much tax must be paid when making quarterly estimated tax payments, and taking full advantage of the available deductions, you can determine how to minimize your tax burden and avoid penalties. At John D. Teter Law Offices, we can help you ensure that you meet all of your obligations, and we can help you address issues related to non-compliance or tax penalties. To learn how we can assist with tax-related issues, contact our San Jose, CA business tax attorney at 408-866-1810.

Sources:

https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes

https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes

https://www.irs.gov/publications/p505