Wed, 24 Aug 2011
I filed my taxes Tuesday night. It wasn't quite the relief it usually is
though. This was the first year in which my income was mostly 1099 income.
That means that self-employment tax reared its big ugly head. I knew it was
coming, but when it looks you in the eyes, it's still frightening. After
writing off my business expenses, my total taxes were actually about $3,000
less than the rough estimate I made last year when filling out my 1040-ES.
Nonetheless, I still owed the feds over $10,000 of the almost $19,000 total tax
liability.
What makes the number so shocking is when you compare it to a return for which
all of the income is W-2. With W-2 income, the section of the 1040 labeled
Other Taxes is generally blank. As an employee, you pay 7.65% of your wages
for Social Security and Medicare insurance, but this amount doesn't show up on
your tax return. When your self-employed, the 15.3% tax on your net business
profit shows up under Other Taxes, increasing the bottom line (line 62, that
is) substantially.
One nice thing about being self-employed is being able to write off business
expenses that employees typically can't. This year, I expensed gas and other
automotive expenses, internet access, office supplies, part of my rent and
utilities, and depreciated computer equipment and part of my car. Working from
home, I don't have too many expenses so I was only able to reduce my gross
income by about 6% in calculating my net profit. I was also able to write off
my health insurance premiums, but that only reduces my adjusted gross income
rather than business income, and thus doesn't reduce the SE tax. So I was left
with a large amount of self-employment tax to pay.
In 2005, I'm going to set up and contribute to a SEP-IRA and a Health Saving
Account which will reduce my income tax, but not my SE tax unfortunately. To
reduce my SE tax, I may form an S Corporation. Paying myself half the
corporate income in salary, which is subject to SE tax, and rest as a
distribution, which is not, would probably be fair and would reduce my SE tax
by quite a bit.
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