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SELF-EMPLOYED TAX CONSIDERATIONS

Who is considered “self-employed”?

a) An individual who carries on a trade or business as a sole proprietor or independent contractor.
b) A partner in a partnership that carries on a trade or business.
c) An individual who carries on a business by him or herself, even part-time.
 
When beginning a business, you must decide what form of business entity to establish. The form of business determines which income tax form to file. The most common forms are sole proprietorship, partnership, corporation and S corporation. There is also the Limited Liability Company (LLC), which is a relatively new structure allowed by state law.

Running a business as a self-employed individual requires you to pay taxes quarterly on your net income, which is called “estimated tax.” At year end, you must use Schedule C to determine your net profit. This net profit could be the basis on which to calculate your tax obligation and your social security tax.
Most likely, a self-employed person would seek professional help to prepare tax documents and for advice on tax matters. Taxpayers are legally responsible for what is on their tax returns even if they are prepared by someone else. Therefore, the choice of an accountant is very important.

A couple of points to consider when selecting a tax professional:
a- The professional qualifications and history
b- The professional’s accessibility for questions and consultation

A few cautions for ensuring an accurate tax return:
a- Be open with your professional and provide all records needed.
b- Never sign a blank return.
c- Review the entire return before signing.

EMPLOYMENT TAXES

• Social Security Wages Base: Wage base increases for 2012 will be $110,100. This is $3,300 more than the base of $106,800, which has been in effect the last three years. The employer tax rate for social security remains unchanged at 6.2%. The 2011 Medicare tax rate is 1.45% each for employers and employees, and this is unchanged from 2010. There is no wage base limit for Medicare tax. In 2010, the Tax Relief Act reduced the employee tax rate to 4.2%; this reduction is scheduled to expire as of December 31, 2010. However, there are several proposals currently under consideration, and if adopted, they would reduce the rate for 2012 below 6.2% for both employers and employees.

• Federal Unemployment Taxes: Employees do not pay this tax nor is it withheld from their pay. FUTA tax is paid separately from Income tax, Social Security tax and Medicare tax. It is paid 100% by employer.

• Self-Employment Tax (SE): SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wages earners.

• Reporting Employment Taxes: In general, employers are responsible for deducting, collecting, paying and reporting federal Income tax, Social Security tax and Medicare tax. Although the payment of taxes could be submitted monthly, the reporting is done quarterly on Form 941. Employers who have an employment tax liability of $1,000 or less for the year may file Form 944 (Employer’s Annual Federal Tax Return) instead of quarterly Form 941.

• Filling Form W-2: At the end of the year, employers must complete Form W-2 to report wages, tips and other compensation paid to their employees. A copy of this form must be given to each employee by January 31 after the end of the year. Also a copy must be sent to the Social Security Administration.

• Outsourcing Payroll Duties: Many employers outsource some or all of their payroll duties to third-party payroll service providers. It is very important for employers to understand that they are ultimately responsible for the payment of Income tax withheld and both the employer and employees’ portions of Social Security and Medicare taxes.

• Independent Contractor: it is very important for employers to determine whether the individuals providing services are employees or independent contractors. Facts that prove independent contractor status provide evidence of the degree of control the employer has over the employee and the employee’s independence. These fall into three categories.

To determine the worker’s status, ask:

1. Does the employer control or have the right to control what the worker does and how the worker does his job?
2. Does the employer control the financial aspects such as how the worker is paid, whether expenses are reimbursed and who provides tools and supplies?
3. Is the employer-worker relationship documented as to any type of benefits such as pension or vacation?

If the answers to one or more of the above are “yes,” the worker is more likely to be considered by the IRS to be employee rather than an independent contractor.

The key to determining employee or contractor status is to look at the entire relationship within the parameters of the degree of control and the right to direct and control the actions of the worker, and to document each of the factors used in coming up with the determination. If it is still unclear whether the worker is an employee or an independent contractor, Form SS-8 can be filed with the Internal Revenue Service, which will review the facts and officially determine the worker’s status. If the employer classifies an employee as an independent contractor and the employer has no reasonable basis for doing so, the employer may be held liable for employment taxes for that employee.
 
There are tax advantages for the self-employed. For instance, a personal expenditure that might now be an allowable business deduction, and an independent contractor or business person may now have tax costs that did not apply when that individual was an employee. Good record-keeping is essential and a self-employed worker must diligently record all expenses and income and document all with receipts. Your tax professional will guide you as to the categories of income and expenses that apply and the methods of record-keeping that work best for your type of business.




©2011, Mahmoud & Associates