Tax Aspects of Self-employment

As a sole proprietor, you would report net income or loss from your business on your personal income tax return. However, there are several important rules that you should be aware of:

1. For income tax purposes, you will report your income and expenses on Schedule C of your Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will generally be deductible. If you have any losses, the losses will generally be deductible against your other income, subject to special rules relating to hobby losses, passive activity losses and losses in activities in which you were not "at risk."

2. You will also be required to pay self-employment taxes at a rate of 15.3% on your net earnings from self-employment of up to $61,200 for 1995,and at a rate of 2.9% on the excess. (The $61,200 maximum will be reduced by any non-self-employment wages you earn.) One half of your self-employment taxes will be deductible as a trade or business expense (that is, as a deduction against gross income, not subject to the limits that apply to itemized deductions).

3. You will be allowed to deduct 30% of your health insurance costs as a trade or business expense. (The remaining 70% is treated like any other medical expense, deductible, if at all, as an itemized deduction.)

4. Your income will not be subject to withholding tax. However, you will be required to pay estimated taxes quarterly. We can work with you to minimize the amount of your estimated tax payments while avoiding any underpayment penalty.

5. You will have to maintain complete records of your income and expenses. In particular, you should pay attention to recording your expenses in order to be able to take the full amount of the deductions to which you are entitled. Certain types of expenses, such as automobile, travel, entertainment, meals, and home office expenses, are subject to special recordkeeping requirements or limitations of their deductibility and require special attention.

6. If you hire any employees, you will have to get a taxpayer identification number and will have to withhold and pay over various payroll taxes.

7. You should consider establishing a qualified retirement plan. The advantage of a qualified retirement plan is that amounts contributed to the plan are deductible at the time of the contribution, and are not taken into income until the amounts are withdrawn. Because of the complexities of ordinary qualified retirement plans, you might consider a simplified employee plan (SEP), which requires less paperwork. If you do not establish a qualified retirement plan, you may make a contribution to an IRA.