Taxes

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Taxing Small Business

Terry Savage

About 134 million Americans will file tax returns in the coming weeks. And about 20 million of those returns will include Schedule C - the page that reports your income from self-employment. Whether you're a freelance writer, or a baby sitter, or a seller on eBay(EBAY Quote), if you have earned income that wasn't taxed as wages, you'll have to file Schedule C.

That's the bad news -- more work reporting income for the self-employed. But the good news is that being self-employed means you also get more potential deductions.

Figuring out how much you owe in taxes can be quite a challenge for the self-employed. It becomes even more complicated if you also have a regular job, with income that is reported from your employer on a W-2 form. Separating not only income, but deductions, can be a paperwork nightmare.

That's where TurboTax Home and Business comes in. The latest version of this product serves as a guide to sorting out your personal and business income and deductions. One click displays all the forms you need -- both your personal 1040 form and the Schedule C, which will be filled out together. Because this program is specifically designed for people in your situation, the business income on Schedule C is the first priority.

Life will be a lot simpler at tax time if you've kept a separate checking account and credit card for your business. Then the payments that you've deposited into your business checking account provide a simple record of your income. If you're banking online or using QuickBooks or Quicken (part of the TurboTax family) there will be a place to record each source of income.

It's your job to make sure you report all income. Remember, the other companies that pay you will report those payments to the IRS as an expense of their business. When the IRS matches those returns, you can be sure they'll be asking why you didn't report that income!

Deductions are the other side of your tax ledger. The TurboTax program will help you determine which of your expenses you can write off against that income. The program is actually organized by industry type. So if you're selling handcrafted artwork, it might have a prompt to enter the cost of goods. Less obvious deductions might include the proportionate use of your home telephone, or the potential of a home office deduction.

Once you've completed Schedule C, you can move on to the more traditional 1040 form. If, for example, both you and your spouse have income from a job, you'll enter those figures from your W-2. Your traditional deductions such as mortgage interest, charitable contributions, and childcare expenses will all go on the appropriate lines.

Now, with a click of your mouse, you get to merge your two existences as a wage-earner and an entrepreneur to create your tax return.

If your small business lost money, you can offset that loss against your ordinary income. And if your business lost even more than your income from other sources, it's considered a "net operating loss", which can be carried back two years, and can be carried forward 20 years, until the entire loss has been offset against your other income.

But if your business continues to generate losses that you write off against ordinary income, it will raise a flag. The IRS presumes that if you incur a loss in two out of five consecutive years, your business activity is probably a hobby and thus, the losses are not deductible.

Your income tax is calculated based on all your taxable income, from your W-2 and your self-employment. But your self-employment tax is calculated only on your business income. These two taxes are added together to come up with the total tax on your federal tax return.

Just like the FICA tax on your wages, the tax for self-employed people is made up of both the Social Security tax and the Medicare tax. For 2006, Social Security tax is calculated on the first $94,200 dollars of your income from all sources. Medicare tax is calculated on all of your income.

If you are an employee, you pay 6.2% of your income for Social Security tax and 1.45% for Medicare tax (these are withheld from each paycheck). Your employer pays an equal amount on your behalf. For your self-employment income you must pay both the employer and employee portions - 12.4% for Social Security tax (on your income up to $94,200) and 2.9% for Medicare tax. But you do get to deduct half of your self-employment taxes on line 27 of your 1040 form.

Obviously, there was no withholding on that self-employment income, so be prepared to pay a federal, and possibly state, tax bill. You could ask your employer to withhold more taxes from your wages to cover the amount due on your self-employment income next year. If your withholdings do not cover your tax obligation, you must file a quarterly estimated payment.

To avoid that problem next year, Turbo Tax, a division of Intuit(INTU Quote), will help you calculate a quarterly estimated payment. For the first year of self-employment, the IRS gives you a pass on those estimates, but in subsequent years you must make quarterly payments. To be safe, you should base them on 100% of your previous year's tax, or 110% if your income was over $150,000.

TurboTax for Home & Business costs $89.95, whether you buy if from a local retailer or download it. Included in the price is one state tax program, which you must download. You can file your tax return electronically for an additional $14.95. That will get you your tax refund faster. And if you need to include a check for that extra income when you e-file your return, you'll be given a form to print out and mail along with your check for taxes owed. Or you can have the IRS automatically debit your bank account.

Making money on your own small business is a great use of your entrepreneurial talents. But it also complicates your tax filing. Thank goodness you don't have to spend all your profits complying with the tax laws.

TaxCut, a competing program offered by H&R Block(HRB Quote), also offers a home and business version to help you through Schedule C and your 1040. It's available for $79.95 here.

And that's the Savage Truth.