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Self-Employment and Tax Advantages

The following is a post by Derek from Life and My Finances.

When you work for a company, paying taxes is pretty simple isn’t it? You don’t need to keep track of your income or the amount of taxes you’ve paid in. Your company keeps tabs on all of that for you, and then they send you a W-2 after the year is over! Then, the only tax form you need to fill out is the 1040 which is incredibly straightforward and self-explanatory. Yes, working for a company sure is a breeze when tax time comes around.

It May Be Easy, But Is It The Most Beneficial?

Filling out a 1040 is pretty easy (and cheap if you need to get it done), but it it really beneficial? What if you had a home-based business? What is it like keeping track of all of your own tax information? Is it worth all of the extra hassle?

Disadvantages to Self-Employed Taxes

  • You must keep track of your own income and expenses
  • It’s often more expensive to file a 1099 compared to a 1040

Advantages to Self-Employed Taxes

  • You can write off any business-related expenses
  • You don’t need to pay all of your taxes up-front

What Does It Mean to Write Off Your Expenses?

If you don’t have a business of your own, then you might not know exactly what it means to “write off an expense”. I remember when my friend first started his own business. He was buying things left and right that he always wanted and could be considered “business expenses”. He bought a new laptop, a projector, and a number of other unnecessary, but “cool” products. In his mind, these items were all free because they were deducted off from his taxes, but this was absolutely not the case.

When you “write off an expense”, this merely means that your counting your purchase as a business expense and it gets deducted from your total profits. So, while the product is not completely free, it can be considered a reduced cost because you didn’t have to pay taxes on the amount equal to the cost of your product.

As an example, let’s say you earn $50,000 in your first year of business, but in order to keep improve your profits, you had to buy a few tools. To do this, it cost you $10,000. When it comes time to pay taxes, you’ll pay tax on your overall profits, which is $40,000, not on the full $50,000. So, your savings are the amount that you would have paid in taxes with that $10,000. Instead of paying that extra $3,000 (if we figure 30%) in taxes, you don’t owe anything on that $10,000. So, essentially, you paid $7,000 for your tools – they were absolutely not free. ;)

Don’t Prepay Your Taxes

When you work for a company, do you really have any say in whether or not you’d like your taxes taken out of your check? Nope! You might have a little power when it comes to entering your number of dependents, but you most definitely have to pay something in every time you receive a paycheck. So, over the course of the year, the government is holding your money ransom and you aren’t able to earn any interest on those earnings.

If, however, you are self-employed, you do not have to pay taxes every time you receive a check. The government does advise that you pay in a reasonable amount of taxes per quarter, just to ensure that you’ll have the funds at the end of the year. But, during the whole quarter, you could stash a bunch of that cash into a high-yield savings account or a short-term CD. It’s much better to have your money work for you than the government, don’t you think?

Don’t Start a Business For a Tax Shelter

After reading this article, I know that it might be tempting to go out and start a business just so you can write off a few purchases, but I strongly advise that you do not do this. It’s great to start a business of your own – it could provide some extra income and you might even be able to retire earlier because of it – just make sure that you’re starting the business for those reasons and not strictly for the tax shelter. Many times, avoiding taxes can actually do more harm than good. Keep your focus on earning an income and worry about sheltering your earnings later.

Do you currently own a business? Do you enjoy the tax advantages?

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