Employment and Self-employment Taxes
In addition to collecting income tax on businesses, the federal government collects a package of taxes from small businesses collectively known as employment taxes. The amount and nature of the taxes are different for small business owners with employees and for self-employed individuals.
Let's start with small business owners who have employees. First of all, as an employer, you need to apply for an employer identification number (EIN) with the IRS in order to file your taxes. Second, you are responsible for keeping track of three (or four) different taxes related to each of your employees:
- Social Security and Medicare taxes (FICA)– you pay half of these contributions to the Social Security and Medicare trust funds, and withhold the other half from your employees' paychecks
- Federal income tax – your employee is the one who pays, but you are responsible for withholding the amount from each paycheck
- Federal unemployment tax (FUTA) – you pay the full amount for each employee, plus any contributions to state unemployment plans
At the end of the tax year, small business owners with employees must report all of these withholdings to both the IRS and their employees. The employees receive a W-2 form detailing how much taxes were withheld for the year. If you pay independent contractors, you will have to send them 1099-MISC forms showing their nonemployee compensation.
Self-employed people and independent contractors are charged a self-employment tax, which is equal to the full amount of Social Security and Medicare contributions for the year. In 2014, the self-employment tax is 15.3 percent of net earnings (12.4 percent for Social Security and 2.9 percent for Medicare) [source: IRS]. As mentioned earlier, self-employed small business owners can deduct half of the cost of the self-employment tax. Self-employed folks don't have to pay unemployment taxes for themselves because they aren't eligible for unemployment benefits.
For lots more information on employment taxes, federal taxes and running a successful small business, check out the related HowStuffWorks links below.
Author's Note: Tax Guide for Small Businesses
Between my wife and I, we technically run three separate small businesses. You would think this would make me an expert on small business taxes. For the IRS auditors reading this, yes, I am a small business tax expert. For the rest of you, I admit that I'm still getting the hang of it. I'm not worried about breaking the rules; I'm more concerned about not claiming enough deductions. I know that if I kept every receipt from every gas station and office supply store, I could whittle down my taxable income by a few more percentage points. I start every tax year on the right foot, keeping careful track of all expenses in a tidy three-ring binder, but it always devolves into a shoebox full of chaos by December. I promise to do better next year, unless you are the auditor, in which case, I'm perfect!
- IRS. "Closing a Business Checklist" (Dec. 5, 2014) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Closing-a-Business-Checklist
- IRS. "Publication 334 (2013): Tax Guide for Small Businesses" (Dec. 5, 2014) http://www.irs.gov/publications/p334/
- IRS. "Self-Employment Tax (Social Security and Medicare)" (Dec. 5, 2014) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Self-Employment-Tax-Social-Security-and-Medicare-Taxes
- Small Business and Entrepreneurship Council, "Small Business Facts & Data" (Dec. 5, 2014) http://www.sbecouncil.org/about-us/facts-and-data/
- TurboTax. "How an S-Corp Can Reduce Your Self-Employment Taxes." (Dec. 10, 2014)
- U.S. Census Bureau. "Statistics of U.S. Businesses (2011)" (Dec. 5, 2014) http://www.census.gov/econ/susb/
- U.S. Small Business Administration. "Frequently Asked Questions" (Dec. 5, 2014) https://www.sba.gov/sites/default/files/FAQ_March_2014_0.pdf
- U.S. Small Business Administration. "Small Business GDP: Update 2002 – 2010." January 2012 (Dec. 5, 2014) https://www.sba.gov/content/small-business-gdp-update-2002-2010