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The Biggest Trap Facing New Entrepreneurs

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EntrepreneurIn a tough economy, millions of Americans have taken on contract positions in lieu of permanent employment, while many others have unleashed their inner entrepreneur by seeking to start their own businesses. But in doing so, many don't realize some of the hidden dangers that can newly self-employed people right where it hurts most: in the wallet.

The Pros and Cons of Self-Employment

It's no surprise that the number of self-employed workers has risen dramatically in recent years, rising to more than 22.1 million, according to the latest available figures from 2010.

With traditional jobs harder to come by, many people have had no choice but to strike out on their own. Even those fortunate enough to have jobs are often underemployed and can use a self-started business as an outlet to take full advantage of their talents.

Being self-employed, however, is a lot different from having a regular job. On one hand, you get a lot more flexibility in deciding how you do your work. Many workers take advantage of self-employment to build flexible schedules that fit with the rest of their lives.

But they're also on their own to cover a bunch of costs for which employers usually pick up the tab, such as office equipment and supplies.

A Taxing Proposition

One of the biggest extra expenses you'll have to cover is the self-employment tax. With regular jobs, your employer withholds a portion of your paycheck to cover Social Security and Medicare taxes, and then contributes an equal amount of its own money to pay the total tax liability.

Because being self-employed means being both worker and employer, the self-employment tax is roughly twice what gets withheld from your paycheck as an employee, with a 13.3% rate applying in 2012 up to just over $110,000 of income.

More importantly, it's your responsibility to make sure you get your self-employment tax paid, usually on an estimated basis every quarter. If you don't, you could end up owing significant penalties and interest.

When you combine self-employment taxes with the regular income taxes you'll also have to pay, the bill can be quite large, amounting to a third or more of whatever money you receive.

Don't Get Blindsided

The biggest danger with self-employment tax liability is letting it get ahead of you. As long as you know about the tax, it's a lot easier to protect against that danger. But if you don't, it's easy to fall so far behind that it's almost impossible to catch up.

Learn more about self-employment taxes from the IRS website here.

For more on employment: Motley Fool contributor Dan Caplinger has been self-employed for six years now. You can follow him on Twitter @DanCaplinger.

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Bob C

As far as the author went is true, but what he did not say makes all the difference. Yes you have to pay ahead these taxes, this is easy using the estimated tax system. You get a tax deduction of half the self employment tax you pay. Additionally you can deduct all you business related expenses including the equipment you need to meet your business needs. You are also allowed to reduce you business income by 20% up to a max of $45,000 tax free and put it into a SEP (simple employee plan) for retirement. Also you tax on wages is due at the time you preformed the work, but for small business the tax is due at the time of payment. Also in this economic environment contract workers are preferred by many companies and they will pay premium fees for the right knowledge.
If I knew all this when I graduated with a BS degree in Chem E. I would have worked the last 45 years for myself and not for Corporate America.

August 28 2012 at 3:15 PM Report abuse rate up rate down Reply
Bob C

As far as the author went is true, but what he did not say makes all the difference. Yes you have to pay ahead these taxes, this is easy using the estimated tax system. You get a tax deduction of half the self employment tax you pay. Additionally you can deduct all you business related expenses including the equipment you need to meet your business needs. You are also allowed to reduce you business income by 20% up to a max of $45,000 tax free and put it into a SEP (simple employee plan) for retirement. Also you tax on wages is due at the time you preformed the work, but for small business the tax is due at the time of payment. Also in this economic environment contract workers are preferred by many companies and they will pay premium fees for the right knowledge.
If I knew all this when I graduated with a BS degree in Chem E. I would have worked the last 45 years for myself and not for Corporate America.

August 28 2012 at 3:15 PM Report abuse rate up rate down Reply
Bob C

As far as the author went is true, but what he did not say makes all the difference. Yes you have to pay ahead they taxes, this is easy using the estimated tax system. You get a tax deduction of half the self employment tax you pay. Additionally you can deduct all you business related expenses including the equipment you need to do meet your business needs. You are also allowed to reduce you business income by 20% up to a max of $45,000 tax free and put it into a SEP (simple employee plan) for retirement. Also you tax on wages is due at the time you preformed the work, but for small business the tax is due at the time of payment. Also in this economic environment contract workers are preferred by many companies and they will pay premium fees for the right knowledge.
If I knew all this when I graduated with a BS degree in Chem E. I would have worked the last 45 years for myself and not for Corporate America.

August 28 2012 at 3:12 PM Report abuse rate up rate down Reply
Bob C

As far as the author went is true, but what he did not say makes all the difference. Yes you have to pay ahead they taxes, this is easy using the estimated tax system. You get a tax deduction of half the self employment tax you pay. Additionally you can deduct all you business related expenses including the equipment you need to do meet your business needs. You are also allowed to reduce you business income by 20% up to a max of $45,000 tax free and put it into a SEP (simple employee plan) for retirement. Also you tax on wages is due at the time you preformed the work, but for small business the tax is due at the time of payment. Also in this economic environment contract workers are preferred by many companies and they will pay premium fees for the right knowledge.
If I knew all this when I graduated with a BS degree in Chem E. I would have worked the last 45 years for myself and not for Corporate America.

August 28 2012 at 3:12 PM Report abuse rate up rate down Reply
sarahg

In other words, the oppressive governments in the United States make it so legally and financially prohibitive to start a business that all the great corporations of America could never have gotten their start in today's legally extremist, obsessive and oppressive environment. They should leave people the frig alone and make no requirements of them until their businesses have gotten off the ground and have a certain number of employees and a certain annual income. Once that happens, then no reasonable person would have an issue with various requirements. But the governments of this country are so insanely hell bent on controlling every single sphere and aspect of the lives of the people of this country that it really is not a free country. It's only a free country for those who are wealthy. For the rest of Americans, America is a second and third world country. It seems that white, American society is obsessively, neurotically preoccupied with control. They are total control freaks and as such are dangerous people. I find it very interesting that the more deregulation of the wealthy elites of this county, the more they seem to soar and profit like never before--and at the same time, it seems to correspond with increasing, unabated and obsessive regulation of every day people and their lives, which seems to cause increasing economic downward mobility in this country. The profits of the deregulated rich seem to be inverse to the impoverished, obsessively regulated many. The morale here: Get government the FK out of our lives once and for all. Government equals oppression, unhappiness and downward spirals into abject poverty.

August 28 2012 at 12:56 PM Report abuse +1 rate up rate down Reply
jdykbpl45

Obama carw.

August 28 2012 at 11:19 AM Report abuse +2 rate up rate down Reply