Taxes are one of the first surprises for new founders. When you work for an employer, taxes come out of every paycheck. When you work for yourself, nobody does that for you. This overview covers the basics for sole proprietors and single-member LLC owners, based on IRS guidance. It is general information, not tax advice, and your situation may differ.
Two kinds of tax on your profit
The IRS’s self-employed individuals tax center explains that your net profit is your business income minus your business expenses. That profit becomes part of your income on your personal return, so you owe regular income tax on it. On top of that, you may owe self-employment tax.
What self-employment tax is
According to IRS Topic 554, the rate is made up of 12.4 percent for Social Security and 2.9 percent for Medicare, which adds up to 15.3 percent. You usually must pay it if your net earnings from self-employment were $400 or more, and generally it applies to 92.35 percent of those net earnings.
Employees share these taxes with their employers. When you are self-employed, you cover both portions, although the IRS says you can deduct the employer-equivalent part when you figure your adjusted gross income. You can read the details on the IRS’s self-employment tax page.
The forms you will hear about
- Schedule C reports income and expenses from a sole proprietorship, according to the IRS.
- Schedule SE figures your self-employment tax if your net earnings from self-employment are $400 or more.
- Form 1040-ES is used to figure estimated tax payments.
The IRS explains how the first two work together in its Schedule C and Schedule SE FAQ.
Why estimated payments exist
The IRS says estimated tax is how self-employed people pay Social Security, Medicare, and income taxes, because no employer withholds them. The worksheet in Form 1040-ES helps you find out whether you must pay quarterly.
To avoid a shock at filing time, decide early how you will track what you owe. Many founders move a set share of every payment into a separate savings account. A tax professional can suggest the right share for your income and state. Our guide to the separate business bank account shows why that is easier when business money has its own home.
You may need to file even with a small profit
The IRS says you have to file an income tax return if your net earnings from self-employment were $400 or more. If they were less than $400, you may still need to file if you meet any other filing requirement listed in the Form 1040 instructions.
Other taxes to ask about
Federal income and self-employment taxes are only part of the picture. Your state may have its own income tax. If you sell products, you may also need a sales tax license, as SCORE notes in its licensing overview, which we summarize in our guide to business licenses and permits. If you hire people, employment taxes come into play, and the IRS says you need an EIN. Read about getting an EIN and hiring your first help before you do.
Keep records from day one
Save receipts, invoices, and bank statements, and record each sale and expense when it happens. Good records make your Schedule C easier to complete and help you account for the expenses you deduct. Our guide to knowing your numbers covers a simple way to track them.
Where to get help
A local accountant or enrolled agent can look at your specific situation. A small business counselor can help you understand what to ask. Our guide to free business help for new founders lists where to start.
Your next step
Open a simple spreadsheet or notebook today with two columns, income and expenses, and record everything from your first sale forward. Then read the IRS tax center page linked above and write down two questions to bring to a tax professional.