Episode 8: In this episode, Timalyn answers a question she's heard many times, "What is self-employment tax? For a small business owner, this tax can be an unwelcome surprise when they go to file their tax return. It winds up hitting the business owner with a much larger tax liability than originally anticipated. Let's join Timalyn for this episode to learn more.
Self-Employment Tax and Divorce
Timalyn shares a story about how a client ended up owing over $140,000 in back taxes, even though he had filed his taxes. His wife was ready to leave him because he wouldn't be able to go on an anniversary trip. The IRS was preventing him from renewing his passport. After he hired Timalyn to handle his tax relief situation, she pulled his tax transcripts. The transcripts revealed that the majority of the back taxes were due to self-employment tax. He immediately asked her the question, what is self-employment tax?
What Is Self-Employment Tax?
This tax is the entrepreneur's share of social security and Medicare (FICA). As a W-2 employee, your FICA is split between you and your employer's contribution. Generally, that is 7.65% from both parties. An entrepreneur is responsible for the entire 15.3% It consists of 12.4% to social security and 2.9% to Medicare.
In 2022, the first $147,000 in profit is subjected to self-employment tax. You are eligible for the self-employment tax deduction, which is one-half of the tax.
Which Types of Businesses Require the Self-Employment Tax?
Timalyn explains the following are subject to the tax:
The standard deduction does not reduce the amount of self-employment tax you can pay. You can calculate the self-employment tax liability using IRS Schedule SE. It's submitted with your personal tax return. Timalyn will explain how a partner's guaranteed payments are treated, in a future episode.
Do Other Individuals Also Have to Pay the Tax?
Yes, and it may surprise you that these other individuals have to pay the tax:
Should I Switch to an S-Corp to Avoid Having to Pay the Self-Employment Tax?
This is a common question Timalyn handles. Actually, it depends. Timalyn likes the S-corp model, but there are additional costs to consider before making the election to become an S-corp.
It's true, as an S-corp, you would no longer pay self-employment tax. Remember that the tax is a combination of contributions to social security and Medicare. If you choose S-corp status, you are required to be on payroll. You will then go back to paying your 7.65% FICA tax from your wages and the business will also pay its 7.65% share. You're still paying the 15.3%.
However, when done correctly, you should be able to save roughly $0.50/dollar, but there are variables and considerations. Timalyn recommends consulting with a tax professional skilled in tax planning, before you make this decision.
Tax Preparation Expense
Another consideration is that an individual tax return costs less to prepare than a return for a S-corp. The IRS estimates it should take 10-15 hours to complete the Schedule C portion of the return. The S-Corp will use IRS Form 1120S. The form is much more complex and therefore costs more to prepare. Timalyn discussed this in Episode 6 (look for Step 5 in the audio and show notes for that episode).
You will need to provide your tax preparer income statements and balance sheets, each year. This means you may have to be much more diligent with your bookkeeping during the year.
Additional Payroll Expense
If you are an S-corp, you have to be on payroll. Payroll companies obviously charge for these services, so you need to also consider this additional payroll expense. Timalyn does not recommend companies handling their own payroll.
Closing Thoughts
At the end of the day, one could argue that contributing to social security and Medicare provides a benefit to our society as a whole.
For every $100 you make as a self-employed person, you going to have $15.30 going to your self-employment tax (after you made at least $400 profit that calendar year). You also need to set aside funds based on your income tax brackets for federal, state and possibly local tax.
It takes planning and discipline. Don't find yourself in the same situation Timalyn described at the beginning of this episode.
If you'd like to speak with Timalyn and her team about your specific situation, visit www.BowensTaxSolutions.com and click on the blue Book Now button to schedule time. Penalties, interest and other fees are building. Don't wait to address your tax issues.
As we conclude Episode 8, we encourage you to connect with Timalyn on social media. You'll be able to subscribe to this podcast on Apple Podcasts, Google Podcasts, Spotify, and many other podcast platforms.
Remember, Timalyn Bowens is America's Favorite EA and she's here to fill the tax literacy gap, one taxpayer at a time. Thanks for listening to today's episode.
For more information about tax relief options, visit: https://www.americasfavoriteea.com/ .
If you have any feedback, or suggestions for an upcoming episode topic, please submit it here: https://www.americasfavoriteea.com/contact.
Disclaimer: This podcast is for informational and educational purposes only. It provides a framework and possible solutions for solving your tax problems, but it is not legally binding. Please consult your tax professional regarding your specific tax situation.
