If you're self-employed (i.e. you're a sole proprietor and file Schedule C), are you wondering how much federal income tax you may have to pay this year? Now that the year is winding down, this is a good time to address this issue.
If you have a loss in your small business, you'll pay zero federal income tax. By a loss, I mean that your expenses are greater than your income, as reported on Schedule C. In fact, having a loss may reduce your income tax, as it can usually be used to offset other sources of income, if you have any.
Let's take a more positive approach here and assume you have profit from your business. Again, the starting point is Schedule C. If your income (i.e. sales or revenue) is greater than your expenses, you have profit, and that Schedule C profit gets added to any other sources of income you report on Form 1040. So you must realize that the amount of income tax you'll pay on self-employment income depends on whether you have any other income, such as investment income (interest or dividends or capital gains) or wages/salary that you or your spouse receive from an employee job. All your income, including the Schedule C profit, gets added together and is called "Total Income" on Form 1040.
You then get to subtract various deductions from your Total Income to arrive at "Adjusted Gross Income." These deductions are also found on Form 1040, page 1, and include things like IRA contributions, health insurance, moving expenses, and 50% of your self-employment tax.
Next, you get to take the Standard Deduction or Itemized Deductions (on Schedule A), as well as Exemptions for yourself, your spouse, and any dependents such as your children. After subtracting these amounts, you finally arrive at the key number that determines how much federal income tax you'll pay – Taxable Income. You pay federal income tax on this amount based on the tax tables, which operate on the basic principle that the more you make, the more tax you pay on higher levels of income. These tax tables start out at 10% and go up from there – there are also brackets of 15%, 25%, 28%, 33% and 35%.
As you can see, what seems like a simple question (How much income tax will I pay on my self-employment income?) does not have a simple answer. In order to answer this question, you must know how much taxable income you have, and that requires you to go through the same calculations that are done on your personal income tax return. But that's how our tax system works, and this is the reason why many self-employed people get help from a tax professional not only at tax time, but throughout the year.
Once final comment: don't forget that you'll pay not only income tax but also the dreaded self-employment (SE) tax on your Schedule C profit. SE tax is calculated on Schedule SE and for 2011 is 13.3% of profit, down 2% from the normal rate of 15.3%, which is expected to resume in 2012.
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