Starting a side business can help you reach financial freedom. The extra money you earn through your business can reduce debt or be invested. However, it is helpful to understand the benefits and tax obligations of starting a side business before you decide to dive in.
Guest post by Anthony C. Campidonica
Starting a Business
Starting a side business can be as simple as offering a service you already provide. For instance, if you are a bookkeeper as an employee, you may be able to do extra bookkeeping on the side for other companies. You can sell items you already have, such as kid’s clothing. Alternatively, you can resell items to which you already have access. For example, a client I work with is a cycling enthusiast. He was able to track down very hard to find bike parts, and now runs an online business reselling the parts to other cycling enthusiasts.
A side business can present you with favorable tax opportunities. Business owners are allowed to convert personal expenses into legal business deductions if those expenses are considered ordinary and necessary expenses related to the operation of the business activity. These expenses include, but are not limited to, cell phone bills, computer, and meals and entertainment.
As a self-employed individual, you are generally required to pay quarterly estimated taxes for your self-employment tax and income tax.
Self-employment tax (SE tax) consists of Social Security and Medicare tax. It is similar to the Social Security and Medicare taxes withheld from the pay of most employees. You are generally liable for SE tax if you had net earnings from self-employment of $400 or more. Self-employment tax is a percentage of your net earnings from self-employment. Net earnings are calculated as the gross income you derived from your business less ordinary and necessary business expenses.
You are required to pay income tax, which is in addition to the SE tax, on your net earnings from self-employment. This is a tax imposed on your income from your business, which is determined by applying a rate to the net earnings.
Because you do not have an employer withholding Social Security and Medicare taxes, and income tax for you on your earnings, you make estimated payments to pay these taxes. Speak to a tax professional or use the worksheet in Form 1040-ES, Estimated Tax for Individuals to find out if you are required to file quarterly estimated tax payments and if so, the amount of the taxes.
Based on my experience, the taxpayers who were the most organized with their records paid the least amount of taxes because they were able to account for their income and expenses. Learning how to properly substantiate your expenses can save you both time and money. There are many software programs that can help you maintain your records in an orderly and consistent manner.
I strongly recommend you talk to a tax professional regarding the tax implications of starting a business and the tax obligations that come with it.
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About the Author: Anthony C. Campidonica (Tony) spent over eight years as an Internal Revenue Agent (tax auditor) with the Internal Revenue Service (IRS). This experience provided him with unique insight of tax laws and the opportunities provided to the rich. Tony recently wrote Outsmarting the System because he believes that everyone – not just the rich – need to be aware of the constraints of the system and the opportunities provided to them through the tax laws.
Tony is a Certified Public Accountant (CPA) in California and an Enrolled Agent (EA). He holds a Master of Business Administration (MBA) and a Master of Science in Accountancy (MSA).