By Howard Abrams
PBS Tax & Bookeeping
Q: Why is it that the self-employment tax is much higher than my income tax?
A: As a self-employed individual, you owe self-employment tax on your net earnings (net income, Form 1040 Schedule C), in addition to federal income tax. Self-employment tax is actually Social Security and Medicare tax, otherwise known as FICA. Employees pay half the required amount based on income, and their employer pays/matches the other half. Self-employed individuals, however, are required to pay both sides themselves, which is double what an employee pays on the same earnings.
This system guarantees self-employed individuals the same access to benefits, such as Social Security checks, that employees have.
Because the self-employment tax (SET) is taxed on net business income, if you have little or no other income on your tax returns, the SET will be much higher than your income tax. The income tax is based on income minus your itemized or standard deductions and the deduction for exemptions.
When paying your estimated taxes (quarterlies), you need to account for the SET as well as the income tax.
Q: How do I know how much in estimated taxes I should be paying?
A: The government wants its share of a self-employed individual’s (owner-operator’s) current income, similar to the way employees (company drivers) pay their income taxes throughout the year via income tax withholding. The self-employed owner-operators pay their taxes throughout the year via estimated tax payments (quarterlies).
For the current year, we set up the quarterlies after preparing your income tax return for the prior year. The quarterlies are based on the prior year’s taxes (income and SET) and adjusted for depreciation differences. But now is the time to verify that what is being paid is correct. What you need is tax planning, and that starts with an income tax projection.
You now have almost six months of operation for the year, and it is more than enough income and expense information to project your profit and loss for the rest of the year. As a self-employed person, you need to know where you stand before the end of the year in order to make financial decisions.
Changes during the year can raise or lower your estimated taxes. You may be intending to purchase a new truck, take some time off, do a major truck overhaul, fix up your home, or add to your retirement savings.
Will you owe money to the IRS on April 15, 2010? Have you overpaid your income taxes? Is there anything you can do now to reduce your tax liability? Will it help to buy some tires or make a contribution to or just set up a retirement account before the end of the year?
Being able to answer those questions will enable you to plan for the remainder of the year.
Your tax preparer should look at your records throughout the year to spot potential problems or adjust your estimated taxes. A tax projection based on your current operating results will best indicate your tax position going forward. We also suggest your tax projection be updated based on nine months of operations. LL
Everyone’s financial situation is different. This article does not give and is not intended to give specific accounting and/or tax advice. Please consult with your own tax professional.
This article is written by PBS Tax & Bookkeeping Service, a company that has been providing income tax and bookkeeping services to the trucking industry for more than a quarter-century. If you would like further information, please contact PBS at 800-697-5153 or see their Web site at