It has recently come to my attention that many people do not understand how taxes work for people running their own businesses. This is not the fault of people who do not have this knowledge; presumably you don’t know because you’ve never needed to know. I for one have no idea how to handle taxes for a corporation, because I don’t own or run one, for example. But I thought it might be helpful to provide a brief overview on how taxes work for us, because it might provide some illuminating information that may explain a few things.
When I file taxes, like other people filing taxes in the United States, I have to pay income tax on the income I’ve earned in the last year. Just like you[1. For our purposes, ‘you’ is a generic employed person, not you in particular, as you personally may not be in the US, may not be employed, may also be self employed, etc.], I can choose to use itemised or standardised deductions to reduce my tax liability, thereby paying less in taxes. If we earn the same amount in a given tax year after deductions, we will be in the same tax bracket, you and I. We will pay the same percentage of our income in employment tax. Like you, I also pay into Social Security on the basis of how much I make in a given year.
At this point, you and I have paid the same in taxes and Social Security contributions. If we are making roughly the same amount of money, we should be left with the same take home, right? Wrong. Here’s where things start to diverge, because I haven’t paid my self employment tax yet. If you are self employed, or an independent contractor, you owe additional taxes.
Actually, you, employed person, pay those taxes too, you just don’t know it. Because your employer helpfully pays them for you. In fact, your employer also pays additional monies on your behalf that I don’t have to pay, like payments into workers’ compensation funds. If you are injured on the job, you can collect compensation. I cannot. It’s possible, depending on where you work, that you also get benefits like payments into retirement accounts and health insurance, but if you have those benefits, you know about them, and you probably know how much they are worth.
What you are not aware of is how much is paid silently on your behalf by your employer. If you are making, say, $10 US per hour, which is a pretty awful wage, incidentally, your employer may be paying $20 or more in total per hour of your work, depending on a variety of factors. This is why your employer cannot afford to pay you more, even if your employer really wants to.
I’m not trying to come off as patronising here, I’m just trying to explain how it is that while the theoretically highest tax bracket in the United States right now is 35%, I actually pay a whole lot more than that in taxes (and I am not in that bracket). And the same holds true for other self employed people, as well as small business owners. People wonder why we charge ‘so much’ for our services, how it is we aren’t ‘rich’ because on the surface we make a lot of money, well, that’s why. If you were paying the taxes your employer currently pays for you, you’d be in the same boat we are.
Now, I am not necessarily opposed to paying a lot in taxes. I’m not going to lie and say I like doing it, because I definitely do not, and I think our tax system needs to be significantly improved in regards to efficiency, and I am very opposed to my tax dollars going to uses I think are not acceptable, but I don’t, fundamentally, have a problem with high taxes. It’s just that, you know, I hear the government saying it cares about entrepreneurs and small business owners while it pretty brutally abuses us in the tax code. I hear the government saying it wants to help us while corporations are rewarded for their greed. I say I don’t know a lot of about corporate taxes, which is true, but I know that they pay far less, percentagewise, than I do. There’s a reason incorporating is so popular.
I have a completely awesome accountant (local people, if you need an accountant, feel free to email me and I’ll give you his info) who has definitely saved me a lot of money, taxwise, by helping me file my forms properly. But I still shoulder a very heavy tax burden. Like most self employed people, small business owners, and independent contractors I know, I have no savings. I have no health plan. I have no insurance for catastrophes. I can’t, as a friend recently suggested, ‘just take a day off’ because every day off represents lost money. I don’t get sick pay or vacation time. I am treading a thin line and if pushed too far, I will fall right over.
There aren’t easy fixes to these issues. It would be nice to know that the money I am pouring into Social Security will be available when I retire, although as my last Social Security statement helpfully informed me, to be eligible for full benefits, I’ll have to retire at a later age. This is an issue of particular relevance to people engaging in hard physical labour who might much rather retire at 62 than 70, who might actually die if they work until age 70 to get full benefits. It would also be nice if this country did not have a completely dysfunctional approach to health care, if my taxes were paying into a program that would provide me with treatment when I need it.
And it would be awfully nice to see people talking about the significant tax burdens shouldered by people simultaneously paying income and employment tax. I don’t see these costs being adequately accounted for, and it troubles me.