Wednesday, December 9, 2009

Paying your taxes

Self Employment Blog #6

Important details #3

Paying your taxes

Your goal should be to pay a lot of taxes, but the least amount legally required. The government would like to take all your money but have not yet found a way to accomplish this.

Be sure you are sitting down. The taxes on the income from your business can be as high as 40 to 50% of your net profit. It all depends on what other income shows up on your tax return. Your spouse’s salary can push you into this level of taxation, as can investment income, unemployment compensation, or rental income. Here is how it breaks down:

The Social Security Administration gets about 15% of your wages or net income from self-employment to cover your Social Security benefits and Medicare. When you are an employee, you pay half and your employer pays half. When you are self-employed you pay the whole 15%. Your itemized deductions, such as mortgage interest and real estate taxes, do not affect what you pay for Social Security taxes.

Your federal income taxes depend on your taxable income and marital status. This blog cannot provide all the alternatives. A large majority of taxpayers end up in either the 25% or 28% tax brackets. Your actual percentage will vary with your return.

Most states have an income tax. Even some states that do not have an income tax have a business tax that applies to self-employed people. New Hampshire is one of those states. Massachusetts has a tax rate of approximately 5%.

Using the numbers above you would be paying either 45% or 48% in total taxes. Now that you are totally depressed, let me back off from that statement a bit. The taxes you pay depend on how your tax return goes together. High mortgage interest and real estate taxes will reduce your federal taxes. A non-working spouse reduces your taxes. Many of my self-employed clients only pay Social Security taxes because their income is low.

My advice to my clients is to put 40% of their net income into a savings account to pay their taxes. Maybe there will be enough left over after paying the taxes for a cup of Starbuck’s coffee.

The IRS and state departments of revenue require you to pay your taxes during the year, not when you file your return. So you must pay estimates each quarter to avoid being penalized. The due dates are April 15th, June 15th, September 15th and January 15th of the following year. There are vouchers that must be sent in with your check.

The final blog is a glossary of terms you will need to complete the process

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