Self-employment is the opportunity to be your own boss, to come and go as you please, and oh yes, to establish a lifelong bond with your accountant.

If you’re self-employed, you’ll need to pay your own FICA taxes and take charge of your own retirement plan, among other things. Here are some planning tips.

1. Understand self-employment tax and how it’s calculated
As a starting point, make sure that you understand (and comply with) your federal tax responsibilities.

federal government uses self-employment tax to fund Social Security and Medicare benefits.

You must pay this tax if you have more than a minimal amount of self-employment income. If you file a Schedule C as a sole proprietor, independent contractor, or statutory employee, the net profit listed on your Schedule C (or Schedule C-EZ) is self-employment income and must be included on Schedule SE, which is filed with your federal Form 1040.

Schedule SE is used both to calculate self-employment tax and to report the amount of tax owed.


2. Make your estimated tax payments on time to avoid penalties
Employees generally have income tax, Social Security tax, and Medicare tax withheld from their paychecks. But if you’re self-employed, it’s likely that no one is withholding federal and state taxes from your income.

As a result, you’ll need to make quarterly estimated tax payments on your own (using IRS Form 1040-ES) to cover your federal income tax and self-employment tax liability. You may have to make state estimated tax payments, as well.

If you don’t make estimated tax payments, you may be subject to penalties, interest, and a big tax bill at the end of the year. For more information about estimated tax, see IRS Publication 505.


If you have employees, you’ll have additional periodic tax responsibilities. You’ll have to pay federal employment taxes and report certain information. Stay on top of your responsibilities and see IRS Publication 15 for details.

3. Employ family members to save taxes
Hiring a family member to work for your business can create tax savings for you; in effect, you shift business income to your relative.

Your business can take a deduction for reasonable compensation paid to an employee, which in turn reduces the amount of taxable business income that flows through to you.

Be aware, though, that the IRS can question compensation paid to a family member if the amount doesn’t seem reasonable, considering the services actually performed.

Also, when hiring a family member who’s a minor, be sure that your business complies with child labor laws.


As a business owner, you’re responsible for paying FICA (Social Security and Medicare) taxes on wages paid to your employees. The payment of these taxes will be a deductible business expense for tax purposes. However, if your business is a sole proprietorship and you hire your child who is under age 18, the wages that you pay your child won’t be subject to FICA taxes.

As is the case with wages paid to all employees, wages paid to family members are subject to withholding of federal income and employment taxes, as well as certain taxes in some states.

4. Establish an employer-sponsored retirement plan for tax (and nontax) reasons
Because you’re self-employed, you’ll need to take care of your own retirement needs. You can do this by establishing an employer-sponsored retirement plan, which can provide you with a number of tax and nontax benefits.

With such a plan, your business may be allowed an immediate federal income tax deduction for funding the plan, and you can generally contribute pretax dollars into a retirement account.

Contributed funds, and any earnings, aren’t subject to federal income tax until withdrawn (as a tradeoff, tax-deferred funds withdrawn from these plans prior to age 59½ are generally subject to a 10 percent premature distribution penalty tax — as well as ordinary income tax — unless an exception applies).

You can also choose to establish a 401(k) plan that allows Roth contributions; with Roth contributions, there’s no immediate tax benefit (after-tax dollars are contributed), but future qualified distributions will be free from federal income tax.

You may want to start by considering the following types of retirement plans:


  • Keogh plan
  • Simplified employee pension (SEP)
  • SIMPLE IRA
  • SIMPLE 401(k)
  • Individual (or “solo”) 401(k)


The type of retirement plan that your business should establish depends on your specific circumstances. Explore all of your options and consider the complexity of each plan.

And bear in mind that if your business has employees, you may have to provide coverage for them as well (note that you may qualify for a tax credit of up to $500 for the costs associated with establishing and administering such a plan).

For more information about your retirement plan options, consult a tax professional or see IRS Publication 560.


5. Take full advantage of all business deductions to lower taxable income
Because deductions lower your taxable income, you should make sure that your business is taking advantage of any business deductions to which it is entitled.

You may be able to deduct a variety of business expenses, including rent or home office expenses, and the costs of office equipment, furniture, supplies, and utilities.

To be deductible, business expenses must be both ordinary (common and accepted in your trade or business) and necessary (appropriate and helpful for your trade or business).

If your expenses are incurred partly for business purposes and partly for personal purposes, you can deduct only the business-related portion.


If you’re concerned about lowering your taxable income this year, consider the following possibilities:

  • Deduct the business expenses associated with your motor vehicle, using either the standard mileage allowance or your actual business-related vehicle expenses to calculate your deduction
  • Buy supplies for your business late this year that you would normally order early next year
  • Purchase depreciable business equipment, furnishings, and vehicles this year
  • Deduct the appropriate portion of business meals and travel expenses
  • Write off any bad business debts

Self-employed taxpayers who use the cash method of accounting have the most flexibility to maneuver at year-end. See a tax specialist for more information.

6. Deduct health-care-related expenses
If you qualify, you may be able to benefit from the self-employed health insurance deduction, which would enable you to deduct up to 100 percent of the cost of health insurance that you provide for yourself, your spouse, and your dependents.

This deduction is taken on the front of your federal Form 1040 (i.e., “above-the-line”) when computing your adjusted gross income, so it’s available whether you itemize or not.


Contributions you make to a health savings account (HSA) are also deductible “above-the-line.”

An HSA is a tax-exempt trust or custodial account you can establish in conjunction with a high-deductible health plan to set aside funds for health-care expenses.

If you withdraw funds to pay for the qualified medical expenses of you, your spouse, or your dependents, the funds are not included in your adjusted gross income.

Distributions from an HSA that are not used to pay for qualified medical expenses are included in your adjusted gross income, and are subject to an additional 20 percent penalty tax unless an exception applies.
 
 

Hey there!

April is National Financial Literacy Month and one of the best ways, you can gauge your financial literacy is by getting to know financial ratios.

Financial ratios can help you quickly assess how healthy your finances are so that you can take the necessary steps to improve them.

Here at ITB, we created our financial wellness score many years ago called the TScore™.
TScore™ stands for Total Score, and it’s a three-digit number we use to assess a client’s financial wellness.

To calculate a client’s TScore™, we review every part of their financial life, cash flow, net worth, credit management, debt management, etc. Each category is given a score based on a proprietary algorithm used to generate the final TScore™.


Part of our analysis includes the use of 10 financial ratios. Below are five of the ratios you can use to determine your financial health.

Current Ratio
The current ratio is used to determine whether you have enough monetary assets to pay off all outstanding short-term debt.

To calculate your current ratio, add up all monetary assets and divide it by all debt you owe due within a year.

If the answer you get is greater than one, that means that if you paid all your current debt (all debt due within a year), you would still have some monetary assets left over.


Emergency fund ratio
How many months can you get by in an emergency without worrying about your finances? For many people, the answer is zero.

When you know your emergency fund ratio, you have a clear sense of how long you can survive in a crisis 1) without selling your investments or, better yet, withdrawing from your 401(k) (yikes!) or 2) taking a job you don’t want but feel compelled to do so.

Calculating the emergency fund ratio entails adding up all of your monthly living expenses and multiplying by a factor such as 3 or 6.


Monthly living expenses can mean different things to different people.

Here at ITB, we use your monthly fixed expenses total to do this calculation. Why? Because when things get tough (ex. Unemployment), we usually forego the luxuries and focus on paying the necessities (ex. Food, shelter, transportation, minimum payment on a debt, etc.)


Savings ratio
“Mina, am I saving enough?” or “Should I be saving more?” These are two of the most common questions I receive from clients. The best way to answer this is by calculating your savings ratio.

The savings ratio is calculated at the annual or monthly level. Add up all contributions to savings accounts.

Include contributions to retirement plans (include employer contributions if you’re employer matches your contributions and you’re fully vested).

Divide that number by either your monthly gross income or your annual gross income. For example, monthly savings amount to money market account + monthly IRA contribution + monthly 401(k) contribution + monthly

employer contribution divided by monthly gross income).

Aim for 10% or more for a healthy savings ratio.


Debt ratio
Is there such as thing as too much debt? It depends. For some people, $100,000 in debt is too much; for others (ex. a billionaire), it may not mean much to them.

This is why it’s essential to know your debt ratio. The debt ratio tells the relationship between all of your debt and all of your assets.

To calculate total debt, add up all of the debt you owe and divide it by all of the assets you own. Aim for 40% or less, aiming to have no more than four dollars in debt for every ten dollars in assets.


Don’t be hard on yourself if this ratio is really high. Someone who is younger and just graduated from college with a lot of student loans will more than likely have a very high debt ratio. The key is to focus on lowering that number as soon as possible.

Long-term debt coverage ratio
The long-term debt coverage ratio shows you how many times you can make a debt payment using your current income.

One way to calculate the ratio is by dividing your annual gross income by total annual long-term debt payments.

Examples of long-term debt payments are mortgage payments, student loans, car loans, and other debt that will take you more than a year to pay off. Aim for a ratio of at least 2.5.


If you were to flip the formula around, you can determine how much of your current income should go toward covering your long-term debt payments.

For example, the inverse of 2.5 above is 40%, meaning that you should allocate no more than 40% of your income to cover long-term debt payments.

For the full list of ten ratios, including examples and the steps to take to improve each one, join the xChange program.

Reasons people join the xChange:
·     You’ve made a little extra money and don’t know what to do with it
·     You want to learn how to invest
·     You want to leave your 9-to-5 and create a successful business
·     Your side-hustle is not growing like you want and could use guidance from a business advisor
·     Want help finding funding and partnerships for your business.

Members get:
·     A quarterly financial plan & roadmap
·     A completed business plan
·     Step-by-step guidance and walk-through to file your company trademarks
·     4 initial meetings with your financial advisor + quarterly meetings to ensure you stay on track
·     A diversified portfolio
·     Access to monthly deal flow, a curated list of companies to invest in with as little as $100
·     Monthly live Q&As to get all of your financial and business questions answered
·     Monthly live Masterclass with guest experts covering everything from Taxes 101 to building business credit.
·     And so much more!

To learn more, book a complimentary discovery call: BOOK A CALL

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