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Tax Tidbit 03/10: Tax Aspects of Self-Employment

If you plan to go into business for yourself, as a sole proprietor, you may have some questions about the tax aspects of your sole proprietorship.

• For income tax purposes, you will report your income and expenses on Schedule C of your personal tax return, Form 1040. The net income will be taxable to you regardless of whether you withdraw cash from the business. Your business expenses will be deductible against gross income (i.e., “above the line,” and not as itemized deductions subject to the 2%-of-adjusted-gross-income floor or the 3%/80% reduction rules). If you have business losses, they 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.”

• If you will be working from an office in your home, performing management or administrative tasks from a home office, or storing product samples or inventory at home, you may be entitled to deduct an allocable portion of certain of the costs of maintaining your home.

• 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 $106,800 for 2009 and 2010, and at a rate of 2.9% on the excess. (The maximum amount will be reduced by any non-self-employment wages you earn.)

• You will be allowed to deduct 100% of your health insurance costs as a trade or business expense. This means your deduction for medical care insurance will not be limited by the normal 7.5%-of-AGI floor on itemized medical expenses.

• Your income will not be subject to withholding tax. However, you will be required to pay estimated taxes quarterly.

• You will have to maintain complete records of your income and expenses. Certain types of expenses, such as automobile, travel, entertainment, meals, and home office expenses, are subject to special recordkeeping requirements or limitations on their deductibility and require special attention.

• If you hire any employees, you will have to get a taxpayer identification number and will be required to withhold and pay over various payroll taxes, as well as, file quarterly payroll tax returns.

• You may consider establishing a qualified retirement plan. If you do not establish a retirement plan, you may still be able to make a contribution to an IRA.

If you would like any additional information regarding the tax aspects of starting your own business, choice of entity or if you need assistance in satisfying any of the reporting or recordkeeping requirements, please contact Andrew D. Ross, CPA of Bedard, Kurowicki & Co., CPA's, PC (908) 782-7900 x 113, adr@bkc-cpa.com,or visit www.bkc-cpa.com.