A lot of us have hobbies that we enjoy quite a bit and we happen to be quite good at them, and they turn into a little bit of a small business. One of my friends runs a small engine repair shop out of his garage, I happen to be a writer. I don’t make tons of money, but I’m doing what I enjoy, and I’m getting paid to do it.
A lot of us self-employed individuals and small business owners happen have a tendency to take the money in and never think about having to pay taxes on the money. We’re used to just taking the money that comes in and spending it because normally our taxes are deducted for us. When it comes to small business and self-employed income, this isn’t the case. When we’re paid our receivables, nothing is ever taken out, but that doesn’t get us out of paying the IRS.
According to federal law, you have to pay all of the same taxes on your net small business income that you do with regular wages. In addition you will have to pay the employer’s portion of the Social Security tax through what they call a self-employment tax.
Most people do not separate their small business income and their regular income, which can be quite problematic if you don’t keep good books, and most small business people don’t. You need to open a separate checking account for your small business, and put all of your money that you make from your small business into there. Write your checks from your business expenses out of that account, such as business to business services, supplies, and materials. All of the money left over is what’s called profit. Set aside a quarter of your profit each month and put it into a separate savings account. This is the money that will be paid toward your taxes. Setting aside your profit is like using ticketing system.
Now you will have to file what are called quarterly estimates. It’s basically an estimation of the taxes that you owe on your small business income. If you make more than $4,000 each year from your small business, you definitely need to make quarterly estimates. You’ll need to take the money out of that savings account four times a year and mail it into the IRS with a 1040-ES form, which is entitled “Estimated Taxes for Individuals.”
Paying your quarterly estimates is not an optional event. If you don’t, the IRS will charge you interest and penalties when you file your taxes at the beginning of the follow year.
If you have more than just a couple of employees, you should also seriously considering working with an accountant for your accounting and tax purposes, because they will know much more about running the books of a business, various tax deductions, and filing taxes for small businesses.
On a related note, the IRS has created a publication for small businesses which is essentially a comprehensive tax guide for small business owners. Be sure to check out Publication 334, Tax Guide for Small Businesses.