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There's Nothing Like Being Your Own Boss, Except...

© by Fred W. Daily

Martina is leaving that comfortable paycheck and going out on her own to start up Spice World, a gourmet shop. What does she have to know about her tax responsibilities? The first thing that often comes as a shock to the newly self-employed is the quarterly "estimated tax". "The what…?" Martina asks.

It works like this; unless Spice World is incorporated, Martina must make advance income tax payments to the IRS four times a year. If she doesn't, Martina will be fined at tax time, at the rate of 8% per annum. The only exception is for those owing less than $1,000 in taxes. Estimated tax payments cover so-called self-employment taxes (Social Security and Medicare) as well as Martina's plain old income taxes. The coupons for making these payments are available from the IRS, or can be printed out from a tax software program like TurboTax for Business.

As with 85% of all small business operators, Martina will probably start off Spice World as what the tax code terms a "sole proprietor". This means that she'll keep track of her income and expenses and report them on Schedule C., "Profit or Loss from Business (Sole Proprietorship)" attached to her annual income tax return. If Martina's spouse, Phil takes part in Spice World too, they still can report as a sole proprietor. But, if Martina takes her friend Rhonda into the business, it looks like a partnership, and must file a partnership tax form.

Does Martina need any advance approval or registration with the IRS before starting Spice World? No, unless she intends to hire employees in the shop. What if she hires Jolene, a high school student, to help on weekends? Well, now Martina's tax life has gotten more complicated. Any business with employees must;

  1. obtain a separate "employer identification number" from the IRS,
  2. withhold employee income taxes, even for a part-timer like Jolene,
  3. pay the withheld taxes along with the employer's share of FICA (Social Security & Medicare taxes),
  4. file Form 941 quarterly and annual payroll tax reports,
  5. annually file Form 941 and pay federal unemployment taxes (FUTA).

Martina also needs to find out what her state tax authorities require for employment taxes and reporting. Usually, states pretty much mirror the federal requirements but use their own tax forms.

These are just the bare bones tax basics that Martina should know before plunging into the small business pond. For details, see my book Tax Savvy for Small Business published by Nolo Press.

By: Frederick W. Daily, Tax Attorney,
John Raymond, Bankruptcy Attorney, and
Allan H. Rosenthal, paralegal.
All of the three have offices in San Francisco.

© 1997

(This article was originally written for tax practitioners who represent clients before the IRS. But the information presented here is valuable for all taxpayers.)

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