Considering Self-Employment? Here’s What You Need to Know.

August 10, 2022
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Are you considering becoming self-employed and taking control of your own destiny? It can offer a great sense of freedom and financial potential if you have a strong foundation for your business. However, there are tax implications you need to understand. There are some pros and cons to self-employment, as well as some common misconceptions.

Types of Self-Employment

First, it’s important to know there are different types of self-employment. You can go out on your own as a freelancer or independent contractor, or you can create your own legal business entity. There are different business structures to consider like DBA (doing business as), sole proprietorships, partnerships, LLC (limited liability corporation), S-Corporation and C-Corporation. It is important to find the best legal structure based on your business plan, income sources and tax implications.

For example, establishing an S-Corporation will allow you to avoid the dreaded federal self-employment tax (click here to read more on this important topic). Otherwise, you will have to pay extra taxes that can be really expensive. You will be taxed 15.3% on the first $147,000 of net self-employment income claimed on your Schedule C tax filing. This covers Social Security tax plus Medicare tax. If you make over $147,000, the Social Security tax won’t increase any more, but the Medicare tax will continue to go higher and the tax liabilities add up quickly.

It will be important to speak with your financial planner, business advisor, lawyer and/or tax preparer to determine the best legal business structure to minimize your business tax and self-employment tax liabilities.

Misconceptions of Self-Employment

Many workers stuck in everyday jobs may have a rosy view of self-employment. It might seem like a dream to be your own boss and have control over your own business. This is true on some levels, but the financial reality not be as picture perfect as you imagine—at least not without proper planning.

Contrary to popular belief, there are some misconceptions about self-employment. Being self-employed will NOT allow you to:

  • Write off ALL your meals as business expenses
  • Deduct entertainment costs
  • Deduct ALL transportation expenses
  • Write off cost of owning or renting a residence you use as a home office

Self-Employment Advantages and Disadvantages

There are some tax advantages and expenses you will be able to deduct, but the tax benefits do have plenty of limitations. You will also have to factor in some additional expenses that come from leaving a steady job with employee benefits paid for by the employer. You will be on your own when it comes to paying for:

When venturing off on your own as an independent contractor, sole proprietor or owner/partner of a business, you are taking more risk and the tax implications can be much more complex compared to a regular job where the taxes are taken out of your paycheck automatically and you have less skin in the game.

Self-employment or starting your own business may be exactly what you need to achieve your own financial independence. Or, it may not be the best decision for you at this time. Everyone’s situation is different, which is why it is important to have a good business plan, understand the tax implications and establish the proper business structure.

Illumination Wealth can help you with these important life and business decisions. Talk with our team and see what your best path is on the journey to financial independence. Let us help you decide if self-employment is the right move and, if so, approach your new business with the right financial strategies. Contact us today!