By Tim Frye
When it comes to the tax code, confusion is the rule, not the exception. With the code itself topping out at over 70,000 pages, and an average of one tax law changing a day, even a tax genius can get lost in the labyrinth. It is important to understand the parts of tax law that pertain to you or to your client, so you can benefit from the loopholes available for tax avoidance. Having a side business while still working as an employee is a great way to lower your tax bill at the end of the year, and this article will show you how?
America was built on its people taking life by the bootstraps and going it on their own in business. Being self-employed can certainly have its pitfalls, but the level of autonomy offered is one of its greatest attributes. In terms of taxes, a business owner will have to pay the self-employment tax of 15.3% in addition to the effective tax rate on their taxable income. So when it comes to starting your own business you have to weigh out the ramifications, and decide whether you have the time and resiliency to make it happen. There is nothing wrong with a comfortable and cosy employee salary, where your responsibilities are compartmentalized and the whole business is not solely on your shoulders. The ceiling, however, for self-employment is without a doubt much higher than for the average employee.
Now, to the loophole at hand. When you are working for a company as an employee, you are paid under the W-2 format. Your FICA taxes are paid, your federal income tax is extracted from your check , and before you even see a dime of your own money, it has been shaved significantly. When you are self-employed, the taxes are to be paid as estimated taxes quarterly, or at the end of the year come tax time.
In the first few years after starting a business, you are likely going to have a business loss. With start up costs, and you simply learning the way to make money independently, it is going to take time to end up out of the red at the end of the year. This can be used to your advantage if you are still an employee and have a side business.
If you take a business loss and are still an employee, you are giving yourself an extra deduction that will lower your taxable income further. So let’s say you made $30,000 as an employee, and then had a Schedule C loss of $10,000 for the year. You are going to have your income lowered from this adjustment to $20,000 before your other standard deduction and exemption amounts are levied against income. So if you are in a 15% marginal tax bracket, that means that the $10,000 business loss saved you $1,500, dollar for dollar. That’s some serious dough boy.
How Many Years in a Row Can I Claim a Business Loss?
There are significant catches to claiming a business loss year after year. The IRS generally limits a taxpayer to three years of claiming a business loss before they assess the situation and classify your venture as a hobby and not a business. So you have three years to levy a loss against your employment income and save some money, but after that you better not be in the red or Uncle Sam will happily tell you that your business is in point of fact not a business at all. And when your efforts are classified as a hobby, you are not permitted to take a loss. Hobby loss can only eliminate hobby income, and cannot go any further then that to be subtracted from other sources of income. Good luck with your venture. And if you have any other tax related quandaries feel free to visit Prontotaxclass.com and keep yourself up to date on the latest tax issues affecting you and your clients!