At Molen & Associates we’ve specialized in business income tax preparation for people who have it as both their primary and secondary incomes for over 35 years. Here I’ll explain three uncommon tips I give my clients when they let me know they’re going to start a business on the side.
How much will the self-employment tax affect you?
Put simply, the self-employment tax is 15% of your net profit from self-employment activities in an extra tax. It goes towards social security and medicare. However, there is a cap on how much you can pay into the social security administration each year. This is based on some indexed tables and varies each year, but for 2020 the social security tax is capped at $8,537.40. This means if you earn more than $137,700 as an individual, you’re already paying the max into social security. If this is the case, then you won’t be subject to the total 15% self-employment tax as only the medicare portion will be in effect. The medicare portion is 2.9% of the total 15%, which could significantly lower your expected tax on business income.
Even if you don’t pay the full $8,537.40 of social security tax on your full-time job, you may eventually reach that cap as you pay the full 15% self-employment tax, which could then reduce future tax on your side business profits.
Establish a business bank account
Okay, I know you think this one may not belong on this list as an “uncommon” tax tip. However, let me explain why this belongs in a rarer category. Unknown to many is that the IRS can require the use of a separate bank account as a qualifier for using the Schedule C “Business Income and Expense” form used to report your side business’ activity on your personal return.
It’s important to note that in most cases you’ll want to start your business by registering for a DBA, or “Doing Business As” which will then allow you to open a business account at a bank in your business’ name. By doing this you’ll meet one of the important, but lesser known, qualifiers to be able to use a Schedule C form.
I’ll add to this that many people just up and form an LLC for their new business without seeking proper tax advice. Forming an LLC shouldn’t be done on a whim, you should call us for some insights before doing so!
Charitable contributions from your business
As a sole proprietor (meaning your business is un-incorporated) your business cannot make charitable contributions. This comes as a surprise to many who think they can write a check from their business account and use it as a write-off. To be clear the contribution is still valid, but it comes from you as a sole proprietor, not from the business. This means you’ll have to use it as an itemized deduction. The Tax Cuts and Jobs Act passed in 2017 and makes itemizing very difficult as the new standard deduction is $12,000 for a single filer and $24,000 for married filing joint filers. Often this results in far fewer benefits to itemizing deductions and more people claiming the standard deduction. This in and of itself isn’t bad, it came as a great benefit to many, but it means we have less flexibility in filing in some cases.
Here’s the tip though, if you’re contributing to a 501(c)3 from your business account try and make sure you’re getting some type of exposure in return. For example, if you’re sponsoring a charitable event make sure your business name shows up on a list of other sponsors. The check given to the organization is no longer a gift, rather an exchange for marketing services. This doesn’t always work and sometimes you’re giving a gift that will bring you no tax benefit, but when applicable it can really help. This is especially true when a charitable gift is deducted as an itemized deduction and it only reduces your income tax. If it’s an exchange for marketing then it can reduce not only the income tax, but also the 15% self-employment tax, which could almost double its tax deduction potential.
I hope you’ve either learned or found something that will help the side business you currently run, or plan to begin. If I didn’t enlighten you enough, or you’re interested in more, please call us for a free 15-minute consultation. Over 30% of the 2,500 tax returns we prepare annually deal with some form of business income and I personally guarantee you that we’ll teach you something you don’t already know to help you pay less taxes.
Tax Advisory Manager