If you are just joining us, welcome to day 3 of our 3 part tax day series. We’ve already discussed the importance of Sales and Use Tax along with how to tend to the greedy tax monster to make sure you keep him off your back! Today we’re going to dive into Income Tax and the dreaded Self-Employment Tax.
The good news about Income Tax is that you don’t have to start paying it until you have an income. Although, you must be mindful of how many years you don’t claim an income as the IRS defines a business as making a profit 3 out of 5 years, if you don’t show a profit regularly then the IRS will deem your photography a “hobby” and not a “business” therefore making you pay back taxes on all of your previous deductions.
The bad news about Income Tax, is that when you have to pay it by writing checks to the government it’s much more painful then when it is deducted from your paycheck when you were an employee. Therefore, it’s incredibly important to PLAN for paying your taxes so you aren’t surprised come tax day.
First, research exactly what income taxes you will owe by researching your local, state, and federal tax rate. For instance, I must save 1% for my local township, 3% for Pennsylvania, 25% for Uncle Sam, that brings me up to 29 cents from each dollar that I pay myself for taxes. This rate will be different for everyone as your local and state taxes will vary. You may even be lucky enough to live in one of the 9 states without income tax. This is one of the many reasons I miss living in Florida! Your federal tax rate will also vary depending on if you have a working spouse, second job, etc… To muddy the waters even father, the federal government often changes the tax rates or brackets in the 11th hour. Just this year they voted on extending the Bush era tax rates for 2011 on December 31, 2011. It’s better to save a smidge more and pay yourself a bonus after you pay your taxes then to have not saved enough in my opinion!
All of the calculations above do not account for the most miserable punch in the gut from the greedy tax monster, the self-employment tax. The self-employment tax is a tax consisting of Social Security and Medicare taxes for individuals that work for themselves. This adds another 15.3% tax on all of your income up to $106,800. When you work for an employer you are responsible for half of that tax out of your paycheck, however your employer pays the other half. When you have the pleasure of working for yourself you are responsible for the full amount.
Based on the above calculations, I am responsible for saving almost 45% of my income for taxes. Excuse me while I just threw up. Thankfully, my actual tax rate is closer to 35% due to various deductions in my personal taxes. That’s just a smidge more palatable, barely. I have found that the easiest way for me to ensure that I have saved enough money to pay my tax bill is to create a separate savings account and simply move 35-45% of my take home pay into that account. After I pay my taxes, if there is money left in my account it’s a nice little tax bonus for me. It’s kind of like getting a tax refund but you were able to earn the interest on it instead of Uncle Sam.
I would like to issue a disclaimer on this series. I am NOT a CPA! Although I am a bit of a masochist and actually enjoyed doing my own taxes prior to owning a business, always double check this information with your CPA. If you do not have a tax professional helping you with your taxes, find one! The United States, and all of the 50 states within, has extremely complicated tax codes that are often changing. The federal tax code alone is over 7,000 pages. Flat tax anyone?
The money you spend on your tax advice will often pay for itself by saving you from overpaying the greedy tax monster. Or worse, underpaying the greedy tax monster and then having them come back for everything!
If you aren’t a member of Professional Photographers of America (PPA), I highly recommend that you join. They have a wonderful CPA on staff in the Studio Management Services (SMS) who is available to answer questions for all members, whether or not you are a SMS client. While PPA can’t be your main tax advisor, it is an incredible resource for the occasional question. If your CPA has a question about how a particular tax applies to the photography industry, SMS will talk with your CPA to help clarify.
Remember the silver lining to having to deal with all of these tax issues; you are creating a profitable business!