We have a slew of clients who are running a lifestyle business.  They like to be known as solopreneurs, but with annual turnovers less than $ 50,000,  creating a formal business enterprise is not in the cards- because the return on investment would be too low.  (We do have a bunch who clearly want to have at least $ 50,000 BELOW the line- those  clearly need more formal structures.)

With revenues under $ 50,000, it is simpler to operate as a DBA (doing business as) or a disregarded LLC (an LLC with only one stockholder).  The needs for formal reporting and accounting are greatly attenuated.

Amazingly, over the past decade or so, the number of workers in the gig/self-employment sector has grown significantly.  Right now 10% of all workers are self-employed (for at least for part of their income).

However, it does mean that every dime of profit garnered from the business will be taxed as self-employment income.  That’s the bugaboo that gets many of these folks in trouble.

Only considering the income tax obligations of the business means that a substantial tax burden is completely missed.  Every employee, every self-employed person is subject to Social Security and Medicare taxation.  But, if one is not just the payee but the payor (the employer or the owner of the unincorporated or disregarded entity),  that means the obligations for employee taxes is doubled- because you have to pay the employer portion also.  To the tune of 15.3% of net income.

So, that’s the first item we train these clients to handle.  To recognize that they need to put away 8 to 15%  of every dollar that crosses the transom.  (The variation is due to how expensive it may be to run the business.)  And, that’s just for Social Security and Medicare.

Moreover, these taxes are supposed to be paid (via estimated tax payments) during the tax year.  If one waits until 15 April to pay them, penalties and interest will accrue to the detriment of the taxpayer’s financial health.

(A key factor to recognize:  These are employment taxes.  The IRS does not make it a general rule to “forgive” parts of these taxes, since they are considered “trustee” taxes- and can easily get the person(s) who failed to pay them in a heap of trouble.  When it comes to income taxes, the IRS has a little more leeway to accept partial payments, to forgive portions of the debt owed.  And, the IRS considers that 25% of the tax gap [the difference between the taxes due and owing and those collected] arises from the self-employed/gig sector.)

These self employment taxes are why it is so critical to track all potential deductions.  Not just because they lower your income tax- they lower the employer taxes, as well.  These deductible expenses include travel, meals, equipment, office supplies, etc.  Every dollar of expenses you record is lowering your self-employment tax by 15.3 cents.

Another way to lower the income tax bite is with one’s health insurance costs.  As opposed to W-2 employees (who must exceed a threshold to deduct medical expenses- and then only if they are itemizing expenses, which the new tax law made far more difficult to do), self-employed folks get to deduct health insurance costs from their revenue directly, lowering their taxable income.

And, self-employed folks who earn less than $ 160700 (single)  [$321400 for married folks] get to deduct 20% of their pass-through (self-employment) income from their taxable income.  Assuming one owes income taxes, this can provide a fairly substantial reduction in taxes due.

Self-employed folks also can have better 401(k) and/or IRA plans (meaning more money can be put away tax-free), as well.  Those limits range from $ 7000  to $ 50K for those who opened or maintained a SEP IRA or Solo 401(k) plans during calendar year 2019.

Just some of the perks of being self-employed.

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