A young couple in practice was taken by surprise when their CPA said, “You owe $9,000 in taxes.”
“But,” they said, “we paid the taxes on our income as employees of the corporation.” “Yes, I know,” he replied, “but the corporation also owes income taxes on its profit.” If you were in this situation, would you be prepared to pay $9,000 in taxes?
Yes, you will have to pay taxes on your income as a business owner. But in many cases, you won’t know what your tax bill will be until you come to the end of your first year of practice. It is essential that you estimate your tax bill and set aside enough money during the year so you are not caught by surprise.
Each type of business form has its own taxes, and the income of its owners is taxed differently:
Sole Proprietorship. You will pay taxes on the net profit of the business along with your other income, on your personal tax return (Form 1040). You must also pay self-employment taxes (Social Security and Medicare) at 15.3 percent of your profit. So, if you have a profit of $100,000, you will need to pay income tax on this profit at your personal tax rate, plus $15,300 in self-employment taxes.
Partnership. Partnerships are taxed to the partners in the same way as sole proprietorships, with the owners being taxed on their percentage share. If you and your partner split profits 50/50, using the example above you would have to pay income tax on $50,000 plus $7,650 for your half of the self-employment tax.
Limited Liability Company. A single-member LLC is taxed like a sole proprietorship; a multiple-member LLC is taxed like a partnership.
Corporation. You are an employee of the corporation, so you would be taxed and have withholding on your salary according to the rate you select on your W-4 form. Your half of the FICA tax (Social Security and Medicare) is withheld from your salary; the corporation pays the other half. The corporation must pay taxes on its profits and if you take a dividend or bonus, you must pay taxes on that income also.
S Corporation. A Subchapter S corporation works like a regular corporation, except that all of the profits are taxed to the owners on their personal tax forms; there is no “double taxation” problem with dividends. You must pay tax on your income as an employee.
Remember, the TaxMan Cometh and you must be ready. Create a separate business savings account and start accumulating money every month, so you don’t get caught with a $9,000 tax bill that you must pay.