Today’s article is a guest blog post by David Hoffman.

Picture this: you’ve been working hard and your side gig has been growing. Maybe you’re doing blogging, or you’re into real estate, or wedding planning, and it has gotten to the point where you’re ready to make the leap and turn it into a full time business. At this point it is time to consider taxes for your business 

In my case, I’ve been helping out on a software blog on the side and then the blog owner asked me to join full-time.  I am not an employee of the blog. Rather, I am running my own business as a sole proprietor and I send the owner’s company an invoice each month for work performed.

This article applies to those that are considered sole proprietors in the U.S. and have applied for an Employer ID Number (EIN) via the IRS website.

If you want to learn what tax considerations you need to make as a sole proprietor, then read on to learn what you need to be prepared for.

Sole proprietorship taxes

So you’re self-employed or considering leaving that cushy day job to become self employed. When you’re just starting out, I’d recommend just classifying yourself/your business as a sole proprietorship (assuming it is just you). Eventually you may incorporate which can cost some money in legal fees. There may actually be tax advantages to incorporate and form an LLC, but we’ll leave that for a future article.

Taxes are part of doing business and making money. They’re often associated with negative feelings.  “The government is taking my hard earned money!” It’s better to think about taxes in a positive light — the government provides infrastructure, services, defense, law, among many other things (albeit inefficiently most of the time).

Over the course of our lifetime we end up paying quite a lot of taxes our state, local, and the federal governments. If you’re a sole proprietor this is no different.

When you’re a sole proprietor, you’re responsible for managing your own taxes — you don’t have a company handling this for you. Since you’re acting as the employer and employee you’ve got to keep track of income and what taxes you owe. You’ve even got to earmark funds for taxes either annually or quarterly.

When you’re getting started with your business, this can be quite the burden as it was for me. Eventually it will be part of your financial routine and you won’t have to think twice.

How much do I need to set aside for taxes?

This question, of course, depends on your business income. In general you should expect to pay the following:

• • Federal Taxes – This will depend upon the bracket you’re in.  For example if your income is between $38,701 and $82,500, then you will owe 22% for the 2018 tax year single filers ($37,950 to $91,900 will owe 25% for the 2017 tax year).

• • Social Security – Expect to pay 12.4% up to a ceiling, above which no tax applies. Whoa, whoa, whoa…you might be thinking, “I’m only paying 6.2% right now.” Yes, you’re paying 6.2% (it probably comes out of your paycheck) and your employer is paying 6.2% on your behalf (you never even see it). That second 6.2% that your employer is required to pay is where you might miscalculate how much to save on your taxes. You have to pay 12.4%, but since you’re the employer and employee as a sole proprietor, you can deduct 6.2% as a business expense, effectively reducing your taxable income.

• • Medicare – You will owe 2.9%. There is no income limit or ceiling for this amount.

• State Taxes – This depends heavily on your state (some states have no taxes such as Tennessee and Florida).

By golly! So I need to pay 22 + 12.4 + 2.9 = 37.3% in taxes (not to mention state taxes)?  Yes, that’s correct. So if you make $100,000, you only see $62,700 of it (again, not counting state taxes).

How about deductions?

Neither of these numbers above reflects the business expense deductions you can make. For example I deduct electronics, software, cloud services, learning materials such as books and online courses, office supplies, shipping, and travel. I’m actually lucky that I get reimbursed for some expenses directly related to my number one client. Those expenses that are reimbursed can not be deducted by me — the owner of the website is the one that can deduct those expenses.

If you’re going to deduct expenses (you should), be sure to keep accurate records which you can deliver to your accountant or in the event that you get audited. Sole proprietors get audited quite frequently.

What’s the best strategy to pay these self-employment taxes?

The best thing to do is to estimate these taxes across your monthly and yearly budget, setting them aside monthly in a separate savings or checking account. This money set-aside should be the first line item on your budget in the expenses section. The next line items would be investments and savings followed by rent/mortgage and student loans.

Then each quarter, you’d plan for an estimated tax payment out of your business checking account (or a transfer from the separate savings into your checking, and payment from there). As a sole proprietor there’s nothing wrong with using your personal checking, but you’ll have to keep good records to delineate business vs. personal expenses.

The government generally requires that you make quarterly tax payments if you will owe more than $1,000 in taxes for the year. Some states may require quarterly payments too. In my opinion, it’s best just to pay quarterly rather than writing a big check each spring because the quarterly check will be big enough.

There may be penalties if you don’t pay quarterly or if you didn’t estimate and pay enough taxes in a given year (underpayment).

In general, the tax year will align with the calendar year and the quarterly payments are due on the following dates for the 2018 tax year:

1. 1. April 17, 2018 (1st quarter 2018 estimate & 2017 tax return)

1. 1. June 15, 2018 (2nd quarter 2018 estimate)

1. 1. September 17, 2018 (3rd quarter 2018 estimate)

1. January 15, 2019 (4th quarter 2018 estimate)

If this is your first rodeo, you may elect to consult a tax accountant for help. Seasoned experts should use IRS form 1040-ES to estimate your taxes.

And don’t forget that you’ll still have to file your taxes by April ~15th each year. The estimates are just estimates. You may actually owe more or get money back. One drawback to going out on your own and being self-employed is that taxes are always on your mind every couple months. It requires discipline and planning. If you have a spending problem, you’ll have to curb it really quickly in order to be successful at running your own business.

Part of my strategy has been to not worry about deductions until I file my tax return in April. This way I’ll hopefully get money back or at least not owe additional taxes.  It also simplifies the process of calculating my estimated taxes.

Additional resources

You definitely want to get the full picture — and remember, I’m new at this and I’m not a trained tax advisor. So be sure to consult the following articles on this subject and speak with a tax accountant sooner rather than later:

• • IRS – Sole Proprietorships

• • Nolo – Sole Proprietors: How to pay estimated taxes

• • Turbo Tax – Tax tips for sole proprietors

• Turbo Tax – Estimated Taxes: Common Questions

Summary

Today we learned about sole proprietor taxes (also known as self-employment taxes).

This article applies to unincorporated businesses. If you incorporate, you could actually save money but I’ll leave that for a future article.

If you will owe over $1,000 in taxes for the year (most will), then you generally need to make estimated payments quarterly and then file just as you normally would in April.

It may be a good idea to get an accountant to handle this for you, especially for the first year when you aren’t used to it. Another reason to hire a tax accountant is because they are the experts on the recent tax law change (see How will the new tax law affect me?).

Taxes have a negative connotation but there’s no way around them — so make a plan today using what you’ve learned.

Do you have a question? I’m sure Ben would love to hear from you via a comment or email. You can catch me in the comments as I’ll subscribe to replies on this blog post.

David Hoffman has run a sole proprietor business since early 2017. While he has filed by himself since 2005 each year on Turbo Tax, for the 2017 tax year he has elected to hire a tax accountant to make sure everything is done right. David serves as a consultant and digital assistant for a prominent Python + image processing blog and has served other clients as well. He’s helped author over 40 blog posts (as a ghost) and is starting two blogs of his own. You may find him online and on twitter.