Paying Yourself Can Never Be Bad...

One of the biggest fears that millions of taxpayers face during tax season is having to file that dreaded 1099-Misc income on their returns. You work all year independently not having any federal, state, social security or medicare tax deducted, and now it’s time to pay those taxes.

Suddenly in January, you receive that 1099 in the mail and the sweat starts rolling. You furiously start digging for deductions. The IRS considers you to be a sole proprietor or independent contractor and you’ve got to file a Schedule C (Profit and Loss From Business) with your return. Your Tax Preparer enters your information and when you look at the finished return, you find that Line 58 of your 1040 under “Other Taxes” shows an amount for “Self-Employment Tax”. The first question that most of my clients ask is “What is this and why am I having to pay another tax?”. My first response is “Do you have a 401K or retirement plan?”. They suddenly look at me wondering why I’m asking that question and what does this tax have to do with my retirement. That’s when I begin my spill about “why paying yourself can’t be bad”.

When you’re a W-2 wage earner, your employer is responsible for taking out the necessary taxes, but when you work as a 1099 wage earner, you alone are responsible for the payment of these taxes. Federal tax payments can be made quarterly to the IRS, but self-employment taxes can only be paid at the end of the year when you file your return.

Self-employment tax is composed of a Social Security tax of 12.4% and a Medicare tax of 2.9%. For 2006, the maximum amount of wages and/or self-employment income subject to the Social Security part of the self-employment tax is $94,200. All net earnings are subject to the Medicare portion of this tax. Therefore, if your salary income as an employee is $94,200 or above, you would have already paid all the Social Security tax you owe. Your self-employment income would, however, be subject to the Medicare tax of 2.9%. There is no limit on the amount of earnings subject to the Medicare portion of the self-employment tax.

Simply put, they are social security and medicare payments that you make to yourself calculated on the “net” amount of your 1099 income. They are a mandatory tax imposed by the Social Security Administration, which are enforced and collected by the IRS. When collected, the IRS deposits these funds in your name with the Social Security Administration.

When you look at that final 1040 amount, and you realize that you are having to play catch-up on all the federal, state and self-employment taxes that were not paid during the year….yes, I can see where the sweating would begin. But please take some advice, even though you panic and sweat, don’t just go home and toss the return aside and not file. The result of not filing can result in a tax burden that far exceeds that of the original return balance. Failure to file can result in your having to hire a Tax Resolution service such as Effectur, Inc. to assist you in “making peace” with the IRS.

Remember self-employment tax is you paying yourself in the form of income and health care benefits at your retirement. So, “paying yourself can never be bad!”.

Sharon R. Raines, Financial Planner/Tax Preparer