Kid Entrepreneurs: Don’t Forget About Taxes
Kids and Taxes
Most kids who start their own business do so because they want to make some extra money, maybe so they can buy a car or save for college or just for some extra spending money. I’m going to go out on a limb here and assume that the last thing kids are thinking about when they start a business is the taxes they will owe on any profits they earn.
However, as self employed people, taxes could be one of their biggest expenses. Self employed people are subject not only to federal income taxes, but to self employment taxes as well. As a result, this can be the biggest expense for a self employed person, and can be quite a shock if you’re not prepared for it.
What is self employment tax? Basically, self employment tax represents Social Security and Medicare taxes for people who work for themselves. This tax is used to fund benefits you receive when you retire (old age and hospital insurance). It is also used to pay benefits if you become disabled, or to your family in the event of your premature death (disability and survivor insurance).
Self employment tax is similar to the payroll taxes withheld from the pay of most employees. The biggest difference is that as a business owner, you are required to pay both the employee and the employerís share of the Social Security and Medicare taxes. So while employees of a company pay 7.65%, self employed people pay 15.3% in Social Security and Medicare taxes.
Even worse, this tax is on top of your regular income tax. So if you are in the 10% tax bracket (we’ll assume no state income tax for this example), your taxes on your profit from your business could be over 25% (15.3% self employment tax plus 10% federal income tax).
When do you pay this tax? The federal income tax system is a pay-as-you-go tax system. That means you pay taxes as you earn income throughout the year. If you are an employee of a company, you do this through withholding. If you are self employed, you do this through estimated tax payments.
The general rule is that you must make estimated tax payments if you expect to owe at least $1,000 in tax for the current tax year, after subtracting your withholding and tax credits. Estimated tax payments are due on April 15, June 15, September 15 and January 15 of each year (or the next day if the 15th falls on a weekend or holiday). Failing to make estimated tax payments on time could result in a penalty even if you are due a refund when you file your tax return.
Even if you don’t have to make estimated tax payments, it’s a good idea to set aside 20-30% of your net profits (depending on what tax bracket you fall into) so that you will have enough to pay your taxes when it’s time to file your tax return.
Parents: want to learn how to minimize your family’s taxes? If you have a small business, or if your child has their own business, you’ll want to learn how to hire your children (insert affiliate link) to help minimize your family’s tax burden.
Kristine A. McKinley, CPA, and CFPÆ, offers financial and tax planning on an hourly, fee-only basis. She specializes in helping home based and online business owners understand and minimize their income taxes so they can keep more of their profits. Link to tax blog: www.internetbiztaxtips.com