CD ROM Paradise Collection 4/CD ROM Paradise Collection 4 1995 Nov.iso/business/sba952.zip/F262.SBE

Text File | 1995-05-31 | 8KB | 157 lines

@066 CHAP ZZ

        ┌──────────────────────────────────────────────┐
        │    SELF-EMPLOYMENT TAX ON BUSINESS INCOME    │
        └──────────────────────────────────────────────┘

The self-employment tax is a very painful and onerous tax
on individuals who earn income from self-employment (we
speak from personal experience).  As though one were not
already afflicted with federal income taxes (and state in-
come taxes in many states) and other business taxes too
numerous to mention, the self-employment tax takes another
15.3% (1994 and 1995 rate) of your income, right off the top,
and only half of it is deductible for income tax purposes.
@IF120xx]Since your business is not incorporated, it is quite likely
@IF120xx]that you will be subject to self-employment tax on your in-
@IF120xx]come from your business, @NAME.

That is painful enough; in addition, only your business de-
ductions plus an amount equal to the S/E tax on half of your
S/E income, are allowable in reducing the self-employment
income that is actually subject to this broad tax.  All those
handy deductible items we all use to reduce our income tax,
like home mortgage interest, real estate taxes, state income
tax, Keogh plan or IRA deductions, etc. are of no benefit
whatsoever in reducing the bite of the self-employment tax.

@IF121xx]NOTE REGARDING @NAME:
@IF121xx]-----------------------------------------------------------
@IF121xx]Because your business is incorporated, you need not be too
@IF121xx]concerned with the self-employment tax, unless you receive
@IF121xx]other non-wage (earned) income in an individual capacity,
@IF121xx]such as director's fees for serving on your corporation's
@IF121xx]board of directors.
@IF121xx]-----------------------------------------------------------
@IF121xx]
The self-employment tax is the non-employee portion of the
Social Security tax-raising system.  It is what we pay now
as self-employed persons (in lieu of the FICA taxes paid
by employees--and their employers) in order to earn Social
Security benefits at some distant date in the future, when
we retire--by which time our politicians will have surely
squandered every last $billion of the temporary surpluses
the Social Security fund is supposed to generate for the
next 15 or 20 years, leaving nothing but IOU's for us in
our nation's busted piggy bank.

Perhaps the only good thing to be said for this tax is that
the full 15.3% tax only applies to the first $61,200 in 1995
(or $60,600 in 1994) of one's self-employment income.  Only
the Medicare portion of the tax (2.9% rate) applies to in-
come above the $61,200 amount (or $60,600 amount in 1994),
of self-employment income in 1995 (with NO UPPER LIMIT in
1994 or 1995).

Until a few years ago, you could usually save money on this
particular tax by incorporating your business.  As a corpor-
ation, any salary you paid yourself before 1990 was subject
to both individual and corporate FICA taxes at a combined
tax rate of slightly higher than the rate for S/E tax, but
the higher FICA rate was mitigated by the fact that the em-
ployer's half of the FICA tax was all deductible for corp-
orate income tax purposes, which reduced the net after-tax
cost of the FICA considerably, particularly if the corpora-
tion was in a high corporate tax bracket.

This difference in tax treatment disappeared in 1990, when
both the S/E tax and the combined FICA tax rates were in-
creased to 15.3%.  But now one-half of the S/E tax has be-
come deductible, both for income AND S/E tax purposes, thus
putting self-employed persons on the same footing as incor-
porated ones for Social Security (FICA and S/E) tax pur-
poses.

Note that for some kinds of businesses, such as rentals,
there is no self-employment tax, so that there can be a
considerable advantage in operating those types of busi-
nesses as sole proprietorships or partnerships, rather than
corporations.  (Any wages you pay yourself as a corporate
employee are subject to FICA tax, regardless of the source
of the corporation's earnings used to pay you such wage or
salary.)  Interest income is also exempt from the S/E tax.
@IF159xx]Your firm is engaged in @BUSTYPE, so you most
@IF159xx]likely aren't subject to self-employment tax on any earnings
@IF159xx]that are generated by @NAME.
@IF159xx]
@IF159xx](Regardless of whether or not the business is incorporated.)
@IF159xx]
@IF159xx](@NAME is a @ENTITY.)

Note, also, that although general partners in a partnership
are usually subject to self-employment tax on their distri-
butive share of the partnership's self-employment earnings,
limited partners in a limited partnership are not. (Internal
Revenue Code Section 1402(a)(13).)  However, if limited part-
ners serve the partnership in some capacity, for which they
receive so-called "guaranteed payments" (similar to a sal-
ary), such guaranteed payments for services are considered
self-employment earnings.

A similar set of rules will apparently apply to a limited
liability company ("LLC") that is treated as a partnership
for tax purposes.  However, since there are no "general
partners" or "limited partners" in an LLC (all "members" of
an LLC may work in the business and still have limited lia-
bility), new Proposed Regulations Sec. 1.1402(a)-18(b) of
the IRS provide that some LLC members may be treated like
limited partners, and thus will not subject to the self-
employment tax on their share of LLC profits.  Under state
LLC laws in some states, an LLC can or must designate cer-
tain members as managers of the enterprise. In such states,
the new proposed regulation says that the NON-manager mem-
bers will be treated as limited partners for self-employment
tax purposes, while the designated managers will be treated
like the general partners.  This "limited partner"-like ex-
emption will only be available if the LLC could have been
formed as a limited partnership under the state's law, and
if the member could have qualified under the applicable
local law as a limited partner.

         ┌─────────────────────────────────────────────────┐
         │Even if a non-managing member of an LLC can meet │
         │meet all these tests, this exemption from self-  │
         │employment taxation on LLC income will not apply │
         │till the first tax year after the above-mentioned│
         │PROPOSED regulation is published as a final regu-│
         │lation in the Federal Register.                  │
         └─────────────────────────────────────────────────┘

There is no separate tax return for paying self-employment
tax.  You simply compute the tax on Schedule SE and attach
it to your federal individual income tax form (Form 1040).
The S/E tax is added to your income tax on the Form 1040,
and must be figured into your estimated tax payments as
though it were income tax, in order to avoid penalties for
underpayment of your estimated tax.

WARNING TO SELF-EMPLOYED INDIVIDUALS:

The IRS has recently initiated a scary program to catch
self-employed persons who report one income number to the
IRS and a different (usually higher) number to a mortgage
lender when applying for a mortgage loan.  Under this new
program, the mortgage company simply fills out a short form
giving your name, social security number, and adjusted
gross income on your return that you have submitted to the
lender as proof of your income level.  The lender faxes the
form to the IRS and receives a response verifying the income
level in 48 hours.... Or not.  If there is a discrepancy,
you not only will face problems getting your mortgage loan,
but will be inviting an IRS audit.  According to IRS offic-
ials, initial results of this program (being tested only in
California initially) show discrepancies in about 13% of
cases.  BOTTOM LINE:  If you are submitting a mortgage loan
application, don't submit a phony or "doctored" copy of your
tax return to the lender!