Self-Employment Tax Basics and Getting Current

Many first-time business owners are surprised to learn about quarterly estimated payments and the full 15.3% self-employment tax. The good news is that penalties can often be reduced or waived for your first year.

This is common and fixable. When you work as an employee, your employer withholds income tax and FICA from every paycheck. As a business owner, nobody withholds for you. The IRS requires you to estimate your tax liability and pay it in four installments using Form 1040-ES, due April 15, June 15, September 15, and January 15.

Both income tax and self-employment tax are owed. Your quarterly payments must cover federal income tax on your business profit plus 15.3% self-employment tax (Social Security and Medicare). Many first-time business owners are shocked by the total because they have never seen the employer's half of FICA before -- it was always invisible on a W-2 paycheck.

Your CPA calculates what you owe now. The first priority is determining your current year tax liability and the penalty exposure for missed quarters. If this is your first year in business, you may qualify for a penalty waiver since there was no prior year tax liability to base a safe harbor on. Your CPA evaluates this under IRC Section 6654(e).

The pitfall: Not knowing does not waive the penalty. The IRS applies the underpayment penalty regardless of intent. The sooner you start making payments, the smaller the penalty exposure for the current year.