So you've started a new small business or side hustle. Congratulations!
What Taxes Will I Owe?
This is the most common question I hear from new owners. For service-based small businesses, the two federal taxes that you'll need to plan for are; 1) Ordinary Income Tax, and 2) Self-Employment Tax.
Ordinary Income Tax
This tax is on income that was received from working in a job or business and side hustle where you are personally working in. You'll often hear about this tax referred to in terms of brackets. Each bracket is taxed at a different rate or percentage, and as you earn more, each new dollar earned may fall into a new tax bracket. In 2021, the tax brackets start at 10% and gradually increase to 37%.
Self-Employment Tax
This tax is misnomered by many names such as SE tax, FICA, Social Security and Medicare. While these terms have specific meanings, in general, they refer to a similar tax, which adds up to 15.3% of your income.
Example
Let's say you are single and earned $1,000. You'll pay an ordinary income tax of 10% (or $100), and a self-employment tax of 15.3% (or 15.3%). After taxes (not considering deductions and other tax complexities), you'll owe $253 in taxes, and keep $747.00
Here's The Magic
Taxes for small business owners are based on your profit, not your revenue. Therefore, the way to reduce your taxes is to reduce your profit, by including all of your business expenses deductions. The expenses which you can deduct are any expense which is ordinary and necessary to your type of business.
Example: Joe, made $10,000 in his new side hustle, washing windows. Joe had $6,000 in expenses (website, cell, computer, utilities, business apps, accounting software, supplies, vehicle, storage, health reimbursement arrangements, family help). After expenses, Joe's side hustle profited $4,000, which he will pay taxes on.
Change Your Thinking
Rather than thinking, "Can I write this off?", change your paradigm and consider "How can I write this off?". "Can I" is a black and white thinking process, and the tax rules are straight forward. "How can I" is a greyscale thinking process. It engages your brain into making the case for why an expenses is ordinary and necessary for your type of business.
Example: I was bookkeeping for a client who, like many owners, had a habit of mixing business and personal. I noticed there were frequent pet store expenses. It turns out they had a storage shed with equipment that was necessary for their business. They bought their dog as an alarm system. I explained to them that their dog was necessary to their business because it protected their equipment from theft. If a thief came and stole their equipment, it would prevent them from earning an income and providing for their family. And, it's in the IRS' best interest that you continue to earn income because, the more you earn, the more tax revenue the IRS can generate. In short, we wrote off all the pet expenses because it was an ordinary and necessary expense.
Final Thoughts
As a new business owner, you'll owe the 2 taxes, income and self-employment. However, remember that your business is your most powerful tool into the world of special tax write offs and deductions.
If you need help with your situation, contact us at (425) 298-5453, or info@ontrackadmin.com.
About The Author
Gabriel M. Diaz is the owner of On Track Admin, a company who specializes in admin support, tax support, and bookkeeping for service-based small business owners in Sammamish, Seattle, Bellevue and King County, WA.
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