3 Things to Think About for the Self-Employed and/or Those Working "Off the Books"

Taxes were due April 15, 2010 for 2009 business and personal income and expenses. Hopefully you managed to get them in on time, and had the money to pay your taxes. If you owed, you maybe making payments to the IRS on a monthly basis like I did for many years. This year I got them in on time with a day to spare!

If you got a refund, hopefully you managed to put aside 10-25% for your retirement or a long term investment. It is never too early to think about the days when you can longer work. Once the money begins to accumulate in a savings account, transfer it into a Roth IRA or better yet, have some of your profits from your business go directly into the Roth as a retirement fund, and reduce your net taxable income.

Here are 3 things to think about if you get the urge to cheat and work off the books

1. Credit - How will your credit rating be affected if you don't report your income.

Refinancing your home, or consolidating your debt, can put you in a better position to pay your monthly bills, however it may mean that you mean more in interest over the life of the loan.

Once the economy picks up, and your financial status improves, it might be financially advisable to pay off those long term loans as quickly as possible, after eliminating any debt that is incurred on credit cards if they are higher interest rates.

But if you haven't reported your income, you may not qualify for the loan. If you are earning money and not reporting it, the bank cannot take that income into consideration when you are requesting a loan or refinancing.

2. Social Security Benefits - Will you be eligible for Social Security and what will your average wages be?

On March 7, 2010 the Wall Street Journal did a piece called Cash & Carry, the Perils of "Off the Book Jobs". One of the topics in the newspaper related to social security benefits and those working under the table.

The way social security benefits work is that you need to pay into social security for at least 10 years before you can receive a payout; if you meet all the other requirements.

The next calculation that is considered is your top 35 years of income. If you have less than 35 years worked, then a zero is input for that year, which will lower your "overall overage" income considerably.

Unreported income will negatively impact your annual averages, not to mention being punishable by law and subject to fines.

To correct the situation, you will need to modify or file income taxes against those funds, and then provide the amended information and submit proof of earnings to the Social Security Administration (Wall Street Journal).

The IRS and Definition of Self Employment

The US Social Security Online fact sheet says, "You are self-employed if you operate a trade, business or profession, either by ­yourself or as a partner. You should report your earnings for Social Security when you file your federal income tax return. If your net earnings are $400 or more in a year, you must report your earnings on a Schedule SE in addition to the other tax forms you must file." (Social Security Online)

3. Medicare Taxes - Will you qualify for Medicare?

According to the US Government's website on self employment and taxes, "The Social Security tax rate for 2010 is 15.3 percent on self-employment income up to $106,800.

If your net earnings exceed $106,800, you continue to pay only the Medicare portion of the Social Security tax, which is 2.9 percent on the rest of your earnings.

All is not lost though. Reporting this income, and taking the deductions that can go along with a business, can put you in a healthy position for your long term financial security.

Benefits of filing and reporting income when self employed

There are two income tax deductions that reduce your taxes.

1) Your net earnings from self-­employ­ment are reduced by half of your total Social Security tax. This is similar to the way employees are treated under the tax laws, because the employer's share of the Social Security tax is not ­considered wages to the employee.

2) You can deduct half of your Social Security tax on IRS Form 1040.

But the deduction must be taken from your gross income in determining your adjusted gross income. It cannot be an itemized deduction and must not be listed on your Schedule C.

If you have wages as well as self-­employ­ment earnings, the tax on your wages is paid first.

But this rule is important only if your total earnings are more than $106,800. For example, if you will have $30,000 in wages and $40,000 in self-employment income in 2010, you will pay the appropriate Social Security taxes on both your wages and business earnings.

However, in 2010, if your wages are $77,500 and you have $30,000 in net earnings from a business, you do not pay dual Social Security taxes on earnings more than $106,800. (Medicare & Medicaid Taxes for Self-Employed)

Author's note:

This information is not meant to be professional advice. Talk to a certified CPA or your accountant when you first contemplate beginning a business. They can help you set up your books in a way that makes doing your taxes easier, and they can also guide you on financial decisions that might put you in a bind. Call them before you do something stupid that you live to regret later. Knowledge is power when it comes to managing finances.

Sources:

Wall Street Journal Sunday, 3/7/2010, Cash & Carry, Jonnelle Marte