The Self-Employment Tax Trap
Without employer withholding, self-employed individuals must calculate and remit quarterly estimated taxes. Many underestimate liability and face large balances at filing time. Self-employment tax adds 15.3% (combined employer and employee portions) on net income up to the Social Security wage base. Combined with income taxes, effective rates easily exceed 40%.
Estimated Tax Requirements
Quarterly payments due April 15, June 15, September 15, and January 15. Must pay either 100% of prior year's liability or 90% of current year's (110% for AGI over $150,000). Underpayment triggers the IRC Section 6654 penalty.
Record-Keeping Challenges
Poor records create audit problems when the IRS requests expense documentation. The Cohan rule allows courts to estimate certain expenses, but its application has been significantly limited. Contemporaneous records remain essential protection.
Common Audit Issues
Schedule C filers face elevated audit rates. IRS scrutinizes business losses offsetting other income, home office deductions, vehicle expenses, meals deductions, and worker classification. Each area has specific documentation requirements.
Getting Back on Track
Separate business bank account, record-keeping system, quarterly estimated payments, and professional help filing delinquent returns and resolving outstanding balances. The sooner these steps are taken, the lower the total cost.
Self-employment gives you freedom. It also gives you tax responsibility. Embracing that responsibility from day one prevents the problems that bring taxpayers to my office years later.