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.
The state is that great fiction by which everyone tries to live at the expense of everyone else. - Frederic Bastiat