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Put My Taxes In Buckets, Please… June 10, 2009

Posted by Julie Duriga, CPA in Uncategorized.
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Small Business Tax BucketsAs a small business owner, it is important to understand the differences between the different kinds of taxes that the Internal Revenue Service imposes on business owners.     Taxes don’t fall into one bucket.  There are different buckets for different taxes and it is important to understand the different buckets.

  • The first bucket is the income tax bucket.  Income taxes are paid based on income…makes sense doesn’t it?  Income tax is determined based on your income but also many other factors.  Income tax comes from your income but is offset by many other factors in your life.   Some examples of helpful tax deductions that will reduce your income tax are children, student loan interest, moving expenses (under certain circumstances), Health Savings Account contributions and health insurance if self employed.


  • The Second Bucket is “Self-Employment Taxes”  This is the biggie!  This catches first time small business filers by surprise.  The self employment tax is calculated on profits of your small business.  Profits are important to understand because your business may have profits but your business bank account may be hovering at slightly above zero dollars. Your self employment tax bill will start ticking when you have $300.00 or so in profits.  Your business will pay taxes on profits whether you bring those profits home or not.   Just because you have no money in the bank, profits are still taxable. 


  • Two Buckets Within A Bucket?  Yes!  Within the SE tax there are two buckets.  One bucket inside the SE tax is Social Security and the other bucket is the Medicare tax.


  • This SE tax (self employment tax) is 15.3% of the first $106,800 (limit for 2009) and 2.9% on all profits.    This probably doesn’t make much sense, so here is an example.


  • GIVE ME AN EXAMPLE!  Becky Bookstore decides to open a bookstore because that is her last name and because she loves books.  Her first year in business, her income statement reveals that she has made $150,000 in profits.  She will be taxed as follows for the self employment tax:


  • $106,800 of the $150,000 will receive 15.3% in taxes which equals $16,340.  The $106,800 is a random amount determined and is changed every year by some mysterious government calculation.  For 2010, the limit will be different than the current $106,800.


  • The remaining $43,200 ($150,000-$106,800)  is subject to the 2.9% of Medicare taxes which equals $1,252.80


  • This gives Becky Bookstore a tax bill of $17,592.80


“Yeah, but one half of my self-employment tax is deductible…”  It is true it is deductible for reducing the amount of income tax you might have to pay.   The amount you pay in self employment tax IS deductible but Becky Bookstore still owes the full amount of self employment tax but her income tax will be reduced. 

“I did not pay this much in taxes when I had a job…”     Yes, this is true, because your employer carried one half of the self employment bucket for you.  When  you were employed the SE tax reduced your check by only 7.65% .  When it is taken from your check, it is sneaky and you don’t notice it as much as when you have to write  a check.  Now, that you are self employed, you must carry the full weight of the self employment tax bucket.

Visit us at our website to get your free E-Book titled “How Do I Pay Myself? The Entrepreneur’s Guide to Building a Business AND Bringing Home the Dough.”  www.UniversityForBusiness.com

We also offer a really cool twenty minute video about how running your business affects your bottom line. We use islands, cars and bridges to demonstrate the movement of profits and losses between your personal and business bank accounts. This immediate download is avaialble for only $6.99. Twenty minutes with a CPA for only $6.99, what a deal!



1. Aaron Maret - June 16, 2009

thanks for explaining this. starting to make a little more sense…

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