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Understanding Self-Employment

It takes a great deal of courage, boldness, and strength, to successfully be self-employed. Declaring self-employment status can provide freedom and flexibility, while at the same time requiring much responsibility, consistency and discipline. In other words, there are several pros and cons to being self-employed, some of which can be very rewarding, yet also being incredibly strenuous. Nevertheless, with proper guidance and knowledge one can navigate the path of being self-employed with a bit more ease.


Whether you are performing freelance work or own your business you are considered to be self-employed. Though everyone may know what being self-employed is they often don’t understand what it means to completely and thoroughly be self-employed. There are different types of self-employment status, both unincorporated and incorporated. Each, nevertheless, requires special attention when it comes to tax regulations. When self-employed you are solely responsible for all aspect of the business’s taxes (as well as personal taxes), whether employees are present or not.

When in business for yourself, there are several different types of taxes to consider. Amongst these are income taxes, payroll/employment taxes, excise taxes, etc. The taxes that are assessed are determined by the business’s tax entity. In terms of whether the business is a flow through entity or not.


UNINCORPORATED vs INCORPORATED

  • Unincorporated Businesses are flow through entities that are the simplest form of being self-employed. They are taxed at the individual level and are subjected to a 15.3% self-employment tax. Examples of these include:

*Sole Proprietors/freelancers

*General Partnership

  • Incorporated Businesses most times are flow through entities, except for C-Corporations. Of which only businesses with tax entity classification of S-Corporation or C-Corporation are exempt from self-employment taxes, all other flow through entities are subjected to self-employment taxes. Examples of these entities include:

*Single Member & Multi-Member LLC

*Limited Liability Partnership

*S-Corporation

*C-Corporation


WHAT ARE SELF EMPLOYMENT TAXES?

  • These are taxes that are assessed to individuals who are self employed and has not paid enough estimated taxes throughout the year to cover what should have ordinarily been paid into Social Security and Medicare.

BECOMING SELF EMPLOYED

Unincorporated businesses

  1. Requires no legal filing

  2. Individuals can begin operations on their own terms

Incorporated Businesses

  1. Each entity structure entails different requirement, but all must be registered with their State. (Each State has different requirements, therefore, ensure to check with your State’s website to ensure that you are in full compliance):

  2. Owner(s) typically obtain an Employer Identification Number (EIN)

  3. After which comes:

a. Incorporation

b. Operating Activity License

c. Operating Agreement

d. Local/City Account


PAYING YOURSELF AS A SELF EMPLOYED INDIVIDUAL

Sole Proprietors/Freelancers/Single Member LLC

  • Owner is paid by taking a draw from the business. The draw taken is not tax deductible for the business, however, it is taxable income for the owner.

  • Cannot be on payroll/receive a salary from the business

Partnerships/Multi-Member LLC

  • Partners are only allowed to take guaranteed payments

  • Partners/members cannot be paid a salary

S-Corporation

  • Shareholders who are active within the operation of the business are referred to as shareholder employees, who are required to be on payroll and receive “reasonable compensation”, which is based on years of experience and job description.

  • Distributions can be taken as well, but it must be limited, in proportion to and cannot exceed reasonable compensation.

  • If business income/cashflow is limited, distributions without payroll can be acceptable, but there must be a reasonable cause for not receiving payroll.

C-Corporation

  • Shareholders can be compensated with both a salary and/or dividend

  • Double taxation exists if shareholders receive dividends

INCOME vs. CASH vs. PROFIT

  1. Income: The funds the business earns

  2. Cash: The liquidity of the business

  3. Profit: The result of what is left after expenses are paid, which can also result in a loss. Income-Expenses=Profit

Profit Increases your adjusted gross income (AGI), while a loss decreases AGI. It is the profit that is earned as a flow through entity (except for S-Corporations) that is subjected to self-employment taxes


FOUR TIPS ON BEING SELF-EMPLOYED

  1. Make estimated tax payments

  2. Use a software like QuickBooks or Excel to monitor the income and expenses of the business

  3. Take advantage of tax write offs, such as home office deduction and contributions to an IRA

  4. Become incorporated for liability and legal purposes

The idea behind self employment for most individuals is to have freedom and flexibility, but in order to achieve those components that person must be discipline and consistent. Therefore, having a balance between both sides of the coin can afford self employed individuals the success they have long desired.


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