Child Entrepreneurs: Taxes Could Be Your Biggest Expense

Kids who start their own business do so because they want extra money... some have specific goals such as buying a car, others just want extra spending money. I'm going to go out on a limb here and assume that the last thing kids are thinking about when they start a business is the taxes they will owe on any profits they earn.

However, as self employed people, taxes could be one of their biggest expenses. Self employed people are subject not only to federal income taxes, but to self employment taxes as well. As a result, this can be the biggest expense for a self employed person, and can be quite a shock if you're not prepared for it.

What is self employment tax? Basically, self employment tax represents Social Security and Medicare taxes for people who work for themselves. This tax is used to fund our Social Security program, including retirement benefits, disability benefits and survivor benefits.

Self employment tax is similar to the payroll taxes withheld from the pay of most employees. The biggest difference is that as a business owner, you are required to pay both the employee and the employer's share of the Social Security and Medicare taxes. So while employees of a company pay 7.65%, self employed people pay 15.3% in Social Security and Medicare taxes.

Even worse, this tax is on top of your regular income tax. For example, if you are in the 15% tax bracket, your taxes on your net profit could be over 30% (15% federal tax plus 15.3% self employment tax).

When is self employment tax due? Our tax system is a pay-as-you-go, which means you are required to pay taxes on your income as you earn that income. If you are an employee of a company, you do this through withholding. If you are self employed, you do this through estimated tax payments.

Generally, you have to make estimated tax payments if you expect to owe at least $1,000 in tax for the current tax year, after subtracting your withholding and tax credits. Estimated tax payments are due on April 15, June 15, September 15 and January 15 of each year (or the next day if the 15th falls on a weekend or holiday). Failing to make estimated tax payments on time could result in a penalty even if you are due a refund when you file your tax return.

It's a good idea to set aside 20-30% of your profits (depending on how much other income you have and what tax bracket you fall into) even if you aren't required to make estimated tax payments to make sure you have the money to pay your taxes when you file your tax return.