Start a Business

If you started a new business this year, you joined hundreds of thousands of other new business owners. This Life Event addresses some of the tax issues associated with starting a new business as a sole proprietor.

These issues are categorized into 3 parts:

How Do I File?
Self-Employment Tax
Federal Income Tax

For our purposes, a sole proprietor is someone who owns an unincorporated business by himself or herself.

How Do I File

Use Schedule C to figure your net profit or loss from your business. If you operated more than one business as a sole proprietorship, you must attach a separate Schedule C for each business.

You do not need a Employer Identification Number (EIN) unless you do one of the following:

Pay wages to one or more employees, or
File pension or excise tax returns.

If you have an EIN, include it along with your SSN on your Schedule C. If you need an EIN, you can get an EIN through the mail or by telephone. Note that you must first fill out Form SS-4, Application for Employer Identification Number. This form is available from SSA offices or call the IRS at 1-800-829-3676.

Self Employment

Self-employment tax (SE tax) is the social security and Medicare tax for people who work for themselves. For tax purposes, you are now considered self-employed as a sole-proprietor.

When you pay SE tax, you are contributing to your coverage under the social security system. Social Security coverage provides you with retirement benefits, disability benefits, and medical insurance (Medicare) benefits.

The SE tax rate is 15.3% (12.4% social security tax plus 2.9% Medicare tax). The maximum amount of net earnings subject to the social security part for 2008 is $97,500. All of your net earnings are subject to the Medicare part. Use Schedule SE to figure your SE tax.

SE Tax Example: Kevin Taxpayer, single filer, started a carpet laying business in January of 2008. After working all year, Kevin made a net profit of $30,000.

The portion of SE tax is approximately $4,239.

Note: You can deduct one-half of your SE tax as an adjustment to income on Form 1040. Also, if you earned income as a statutory employee, you do not pay SE tax on that income.

Federal Income Tax

In addition to the SE tax, sole proprietors must still pay federal income tax. The federal income tax is a pay-as-you-go tax. You must pay the tax on income you earn or receive during the year. An employee usually has income tax withheld from his or her pay. If you do not pay your tax through withholding, or do not pay enough tax that way, you might have to pay estimated taxes.

Generally, you have to make estimated tax payments if you expect to owe taxes, including self-employment tax of $1,000 or more, when you file your return. Use Form 1040-ES to figure and pay the tax. If you do not have to make estimated tax payments, you may pay any tax due when you file your return.

Federal Income Tax Example: In the previous example, Kevin Taxpayer owed $4,239 SE tax. Therefore, Kevin must make estimated tax payments.

Based on net earnings of $30,000, Kevin will also owe approximately $2,726 in federal income tax. He has a combined tax amount due of $6,965. Kevin will have to make quarterly estimated tax payments for the entire $6,965. Each quarterly payment will be approximately $1,750.

Quarterly Estimated Payments
If you need to make Quarterly Estimated Payments, the schedule is:

April 15
June 15
September 15
January 15

Penalty for Underpayment
If you do not pay enough income tax and self-employment tax for the year by withholding or by making estimated tax payments, you may have to pay a penalty on the amount not paid.

The IRS will figure the penalty for you and send you a bill. Or, you can use Form 2210, Underpayment of Tax by Individuals, Estates, and Trusts, to see if you have to pay a penalty and to figure the penalty amount. For more information, see Publication 505 (PDF).

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