Welcome to the official blog of Brittany Lanphier, managing partner of Lanphier Accounting LLP based in Denver, Colorado!
Any tax guidance in this blog is intended for informational purposes only and is not guidance on which Lanphier Accounting LLP intends for you to rely. All tax issues specific to your business or family are largely facts-and-circumstances based and you should consult your tax advisor (or Brittany directly) to discuss how this might relate to you.
After a one-week hiatus, the blog is back. I am sure everyone has been waiting on pins and needles for my self-employment tax blog post!
Last weekend, I was lucky enough to take a little time off to visit Chicago with my family. My sister, Stephanie, is a piano performance major at Wheaton College Conservatory of Music, and she had her HUGE senior recital last week. She did a fantastic job, and it was yet another reminder of how miraculous it is that two parents produced such wildly different children – a performing artist and a CPA.
Back on the business-front, tax season is finally in full swing, and my weeks are filling up with tax consultations. It has been very exciting and fun to meet with so many new clients and discuss their tax preparation needs.
One of the most important things I have learned thus far in managing my practice is the foremost importance of client service. This may sound intuitive to those of you who aren’t…well, accountants. Yet, time after time, I meet with a new client only to hear them say, “I’ve worked with another CPA for about three years, but they are so terrible about communicating with me. They are slow to respond to e-mails, never return my calls, and never take the time to ask me questions about my taxes. It makes me feel like I’m not very important to them and that they are probably missing stuff on my return.”
Now, I like to consider myself pretty socially and professionally adept as far as accountants go. I like to think of myself as the “people-person’s accountant.” At the very least, I don’t have any (visible) pocket protectors or wear plaid suspenders. But even I have found that as business picks up, I have to specifically set aside time to answer emails and make phone calls. I can see how for many busy practitioners, especially ones who don’t particularly enjoy the client interaction side of their practice, this can easily get swept aside until they “have a spare minute.”
I feel fortunate, however, to learn this early in my private practice as a CPA, that answering emails and making callbacks is among the most valuable time I will spend in my day or week. As a service provider, while it is essential that I provide a quality work product, it is no less essential that my clients feel like they are important and deserving of my time…whether I am billing them for it or not.
I have read about medical studies showing that the doctors that get sued the least are not those with the most education, certifications, or credentials behind their names. They are the doctors whose patients “like” them – feel respected, listened to, and valued by the doctor. I think no less can be said of any service provider. When it comes down to it, we are all in the business of making people like us. By that, I do not imply a superficial facade by which we manipulate our clients (or customers or patients), but rather a concerted effort to demonstrate our esteem and respect to each person that walks into our business.
On that note, it’s time to turn to…
After several weeks of reading about employment and payroll taxes, you may be thinking, “Man, all of these employment taxes are kind of a kick in the pants. I should just avoid them altogether by working for myself and not being employed at all!” You would think that by partaking in the “American dream” of being your own boss, you might be able to avoid all of those pesky FICA deductions that deflate your regular paycheck.
I really hate to be the bearer of bad news, but rather than rewarding your independence and ambition, the IRS will come along and say, “Okay, you want to be your own boss? That’s fantastic. We just need you to know we will be kicking you in the pants twice every year instead of once.”
Yes, it’s true. When you become your own boss or work independently, you are not considered to be “unemployed” but rather “self-employed,” which means you are both the employer and the employee. You will recall from earlier posts that as an employee your employer contributes half of your Social Security and Medicare taxes (7.65%), while the other half (7.65%) gets deducted from your paycheck. As a self-employed individual, however, you are required to pay both portions in the form of Self-Employment Tax.
Self-Employment tax is a fun little 15.3% (7.65% + 7.65%) tax that gets tacked on the end of your return on any self-employed business income you generated that year. This is totally separate from your federal income tax and none of your other non-business deductions (home mortgage interest, etc.) will help reduce it. As a practitioner, I have found that many new business owners have no idea that this tax exists. However, this is something that can and must be planned around when considering self-employment or starting your own business.
What Income is Subject to Self-Employment Tax?
Your self-employed income is reported on Schedule C of your individual income tax return (Form 1040). This can include anything from owning and operating your own business as a sole-proprietorship or LLC or simply working for someone else as an “independent contractor.”
If you worked as an independent contractor during the year, you should receive Form 1099-MISC, reporting any non-employee compensation, from the payer. You only receive Form 1099-MISC from businesses that paid you at least $600 during the year, however, so keep in mind that it is your responsibility to track your business income and include any additional earnings even if you don?t receive a 1099. All business income should be reported on Schedule C, Line 1.
If there is any good news about self-employment tax, it is that you are entitled to take all of your business deductions before calculating the tax. So if you had automobile expenses, advertising, rent, supplies, or any other “ordinary and necessary” business expense, you get to take that on Schedule C as well. This will bring you to your “Net Income or Loss” from business operations. Keep in mind that you don’t get this luxury as an employee – FICA is calculated on your gross
Another piece of good news is that you are entitled to take half of your self-employment tax as a deduction, just like your employer would if he were paying it on your behalf. This deduction is taken on your Form 1040, not Schedule C, but it is still factored in for calculating your self-employment tax.
How is Self-Employment Tax Calculated?
Self-Employment Tax is calculated on Schedule SE, attached to Form 1040. You start my taking, your net business income from Schedule C. For our example, let’s say you had net income of $30,000 as a self-employed business owner.
First, your net income is multiplied by 92.35%, to take into account the deduction you are entitled to for half of your self-employment tax (100 – 92.35 = 7.65%). So for our example:
$30,000 x 92.35% = $27,705 = Income Subject to Self-Employment Tax
Then, this number is multiplied by 15.3%, giving you your self-employment tax due:
$27,705 x 15.3% = $4,239 = Self-Employment Tax
I am sure you can imagine what an unwelcome wake-up call this is for many small business owners. You put your heart and soul into your business all year, only to learn that you have an additional $4,239 in tax due on top of any income tax you may owe on your earnings!
In reality, business owners are not being penalized for their independence. They are merely being required to bear the tax cost of being both an employer and an employee. Without self-employment tax, it would be far too easy to manipulate the employment tax system by classifying everyone as independent contractors. I know, however, that the tax theory behind it is of little comfort to all the small business owners out there just trying to keep their doors open.
There are several strategies out there for managing self-employment tax as a business owner, which I will cover in a future post. For now, it is just important to know that it exists and that it’s something that must be planned for if you are considering having your own business. Additionally, you should talk to your tax adviser up front, because you are likely required to make quarterly tax payments for your business’ income, in place of the regular withholding that would have been deducted from your paychecks if you were an employee.
I hope this was a helpful look at some of the tax implications of being self-employed. I don’t want this to be a total downer though. There are so many benefits to having your own business, many of them having nothing to do with taxes! Hopefully now, all of you aspiring entrepreneurs will have some additional insight into some planning you will need to do as you move in that direction.
Best to everyone!
Lanphier Accounting LLP
600 17th St., Suite 2800 South
Denver, CO 80202