Tax Obligations for the Micro-Entrepreneur

If you make a net profit in your entrepreneurial business, plan on paying taxes. A profitable home business certainly has tax obligations to be aware of. Here’s an explanation of the tax obligations you can expect to pay as a micro-entrepreneur.

Federal income taxes and the micro-entrepreneur

When you generate a net profit in your business, it becomes a taxable event, and you have to pay a certain amount of federal tax, depending on the tax rate in which you fall. (Check with your tax professional for specifics on how much you may owe.)

Fortunately, if you had a small profit, the income tax won’t break you. In addition, other tax benefits kick in, which can help to shield or offset or even wipe out the potential federal income tax.

Say that your net profit in your business was $15,000; it was your only income and you’re single. The standard deduction for 2012 is $5,950 and the personal exemption amount is $3,800 (per person). Given that, your taxable income is $5,250 ($15,000 less $5,950 and $3,800). Because this taxable income is less than $8,700, you’ll pay a federal income tax rate of 10 percent or $525 (10 percent times $5,250).

In addition, you’ll pay 15.30 percent (self-employment or SE tax) of that net income or $803 (by the way, half of that SE tax is tax-deductible as an adjustment to your gross income, but it’s a tad more complicated, so it’s left out to keep this example simple)

After all that, your total federal taxes to be paid are $1,328 ($525 plus $803). Don’t forget that you also have state and local taxes, which are typically much lower, although some states don’t have income taxes.

As a self-employed person, you won’t have any taxes withheld from your paychecks. As a result, during the course of the year, you’re required to submit estimated payments four times a year (usually April 15, July 15, Oct 15, and Jan. 15, about two weeks after the end of that tax year).

Form 1040-ES can help you estimate your taxes and provides coupons and the mailing instructions for sending in those payments.

You don’t have to be precise when you estimate the taxes; the IRS gives you some leeway, but it does expect that you would have sent in at least 90 percent of your taxes due during the four estimated tax dates and the remaining amounts (if any) by April 15.

You can send any taxes due of $1,000 or less by April 15 of the following year. (April 15, 2013 is the deadline for any taxes due for the tax year 2012, for example.)

State and local taxes for the micro-entrepreneur

State and local taxes are a little trickier for the micro-entrepreneur. Some states have no income tax, and most cities don’t have a local income tax. Most states have an income tax whereas some cities do have a local income tax. Some places have a tax just because you’re a business.

Because each state and municipality is unique, you should work with a tax professional who is familiar with your state and local tax law.

Most states have an economic development agency (or similar-sounding agency) that encourages business development and attempts to make it as easy as possible to conduct business and deal with various state and local bureaucracies. USA.gov has a directory with direct links to the 50 state government websites plus the territories. In turn, these websites usually have links or contact information to counties and municipalities.

Sales taxes on products sold

Depending on what you offer and where your business is located, you may be liable for the collection and submission of sales taxes. To clarify: You (your business) don’t pay the sales tax, but you’re required to collect it and send it in to the sales tax authorities. Basically you become an unpaid sales tax collection agent, working on behalf of that particular taxing authority.

Typically, sales tax needs to be collected at the point of sale on goods that meet requirements for such a tax by that state or local municipality. For example, many states have a sales tax on new goods and not on used goods. The rules vary greatly, so check with the sales tax authority that covers your area and also talk with your tax professional.

Federal and state officials are working on a new sales tax system that will also include a sales tax on Internet transactions. These new developments may be months or years away, but you should keep alert.

To keep abreast of developments, check with the following:

  • Professional associations: They’re usually among the first to find out about pending rules and taxes that affect businesses. Two organizations that would be among the first to see such changes on their radar screens are the National Mail Order Association and the Direct Marketing Association.

  • Your tax professional or accountant: He or she should also be aware of any pending changes.

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