The Basics:
- If you conduct a business activity on a regular basis with the intent of making a profit, the income is generally subject to self-employment tax.
- Ordinary and necessary business expenses are deductible if the business is operated to make a profit.
- You may be able to deduct expenses on your home or car if you use them for business.
- If your tax is $1,000 or more, you generally need to pay the tax quarterly via estimated tax payments.
If you’re in business for yourself, or carry on a trade or business as a sole proprietor or an independent contractor, you’re considered self-employed.
- Self-employed individuals report their income and expenses on Schedule C (Form 1040) or Schedule C-EZ (Form 1040) and are required to compute self-employment tax on Schedule SE (Form 1040).
- If you have employees, you must pay employment taxes, including unemployment tax and Social Security and Medicare taxes and must withhold and remit federal income tax.
- You may need to pay excise taxes if you manufacture or sell certain products; operate certain kinds of businesses; use various kinds of equipment, facilities or products; or receive payment for certain services.
Business Income and Expenses
If you use the cash method, you normally report your business income in the year you constructively receive it and deduct your expenses in the year in which you pay them. If you use the accrual method, you report your income in the year in which you have completed the steps necessary for you to earn it, even if you don’t receive it until the following year. You deduct your expenses when the amount of the expense can be determined and all events that fix the fact that you owe the money have occurred. Special rules apply if you are required to use inventories and to prepaid expenses.
To be deductible, a business expense must be both ordinary and necessary. An ordinary expense is one that’s common and accepted in your trade or business. A necessary expense is one that’s helpful and appropriate for your trade or business.
It’s important to separate business operating expenses from expenses used to figure the cost of goods sold, capital expenses and personal expenses.
Business Use of Your Home or Car
If you use part of your home exclusively and regularly for business, you may be able to deduct expenses for the business use of your home. These expenses may include mortgage interest, real estate tax, rent, insurance, utilities and repairs. You can also depreciate the cost of assets such as office furniture and equipment you acquire for use in your business. You also may be able to deduct in 1 year the cost of certain items you acquire for use in your business by claiming the Section 179 deduction.
You can deduct car expenses using either the actual expense method or the standard mileage rate (56 cents per mile of business use for 2014). If you use your car for both business and personal purposes and claim actual expenses, you can deduct only the business-use percentage of your expenses.
Self-Employment Tax
You owe self-employment tax (Social Security/Medicare) tax if your net income from self-employment is $400 or more. The tax rate is 15.3% on the first $117,000 of net income from self-employment and 2.9% on the remainder. You can deduct half the amount of your self-employment tax as an adjustment to income on page 1, Form 1040. Use Schedule SE (Form 1040) to compute your self-employment tax.
Income Deferral
If you’re self-employed and use the cash basis of accounting (meaning all income is included in the year it’s actually received), it may be advantageous for you to defer some of your income until the next year. For example: A cash-basis plumber finishes a project in December. He can defer the income until the following year by not billing the customer until January. Because he doesn’t receive the income until January, it’s not taxable for the current year. He reports the income in January but can deduct his expenses on the current year return because he paid for them before January.
But you can’t defer income for which you had “constructive receipt” during the year. For example, you can’t defer income if you receive a check during 2014 and don’t cash the check until 2015. See IRS Publication 538 for more information about constructive receipt.
Hiring the Family
If you have your own business, an income-splitting opportunity is to put your children on your payroll. What you pay them is a business deduction for you and earned income for them. You can do this only if they actually work for you, and you can’t pay them more than their services are actually worth. In addition, the wages can be used as a basis for funding your children’s IRA contributions, giving them a start on retirement.
Estimated Tax
Estimated tax is the method used to pay tax on income that isn’t subject to withholding. You generally have to make estimated tax payments if you expect to owe taxes, including self-employment tax of $1,000 or more, when you file your return. Use Form 1040-ES to figure and pay the tax.
For estimated tax purposes, the year is divided into 4 payment periods. The payments are due April 15, June 15, Sept. 15 and Jan. 15. If you don’t pay enough tax by the due date of each of the payment periods, you may be charged a penalty even if you’re due a refund when you file your income tax return.
Small Business With Employees
The Basics:
- If you have employees, you must withhold federal, state and local taxes from your employees’ wages.
- You must deposit income tax withheld and both the employer and employee Social Security and Medicare taxes electronically using the Electronic Federal Tax Payment System.
- You must complete Form W-2 and give a copy to the employee by Jan. 31.
As a small-business owner with employees, you are responsible for several federal, state and local taxes. As an employer, you must withhold certain taxes from your employees’ wages. Federal employment taxes include the following:
- Federal income tax withholding
- Social Security and Medicare taxes
- Federal unemployment tax
Social Security and Medicare taxes pay for benefits that workers and families receive under the Federal Insurance Contributions Act. You withhold part of these taxes from your employees’ wages and you pay a matching amount yourself.
The federal unemployment tax pays unemployment compensation to workers who lose their jobs. You report and pay this tax separately from Social Security and Medicare taxes and withheld income tax. You pay federal unemployment tax only from your own funds. Employees do not pay this tax or have it withheld from their pay.
Depositing Taxes
In general, you must deposit income tax withheld and both the employer and employee Social Security and Medicare taxes by depositing electronically.
You can make your deposits using Electronic Federal Tax Payment System (EFTPS). This is a tax payment system provided free by the U.S. Department of Treasury, which allows businesses to pay federal taxes electronically via the Internet or phone 24/7.
Preparing and Filing Form W-2
At the end of the year, the employer must complete Form W-2, which reports wages, tips and other compensation paid to an employee. The form includes the employee’s withheld income tax, Social Security and Medicare tax and any advanced earned income tax credit payments. A copy of this form must be given to the employee by Jan. 31.
You must also send a copy of the W-2 to the Social Security Administration (SSA). You summarize the Forms W-2 using Form W-3. Filing these forms timely is important to ensure employees are credited with the proper Social Security amounts for retirement. Employers can prepare and file up to 20 W-2s at a time, free of charge, at the Social Security Administration’s Web site. Using SSA’s online W-2 filing, employers can also print out all the necessary copies of the W-2 for their employees, state taxing agencies, etc.
The due dates for filing Forms W-2 with SSA are:
- The last day of February for paper forms
- March 31 for forms filed electronically
Tax Credits
If you hire an employee who is an American Indian or a long-term family assistance recipient or certain unemployed veterans, you may be able to claim a tax credit for a portion of the wages you pay to the employee. The targeted group employee has cerifiaction from the State Employment Security Agency.
