 consequences because we forced the employer to take the money out of their wages for them. So they've been trained not even really to think about it. When they start a new business oftentimes they don't keep up with their tax obligations possibly and then they get hit with possibly the IRS saying that they earned like 100,000 of income when really if they had all the expenses that they wrote off it would be a lot less right because the IRS only has the income side of things not the expense side of things. So you got to make sure that you're tracking the expenses and reporting it so that you can take advantage of those on the taxes so you can report your net income which is the fair thing to report and pay taxes on not the gross income. So net profit or loss subtract your business expenses from your business income to calculate your net profit or loss. This figure is then reported on your form 1040 and is subject to income tax and self-employment tax. We sneak that one in there right because it's also subject to self-employment tax which adds a significant level of complication to the tax return. Remembering self-employment tax is similar to payroll tax meaning it's basically social security and Medicare. When we talk about payroll tax once again the IRS has forced the employer to do the withholding so the employee doesn't really think about it we see it on the W2 but it usually doesn't have an impact on our taxes unless like we overpaid because we had multiple jobs of social security or something like that. But for sole proprietor then we haven't paid in we don't have the payroll so the government can't take the payroll taxes so they want to take the payroll taxes in another format that being self-employment tax resulting in the form 1040 not only calculating the taxes that we owe for federal income taxes but now the social security and Medicare taxes which again is significant. So self-employment tax we'll talk more about this when we get to the schedule C but we'll just touch on it here. So sole proprietors must also pay self-employment tax that social security and Medicare if their net earnings from self-employment exceeds $400 so if you lost money then you might not have to deal with that right but if you made more than $400 then you might have to deal with self-employment tax which is obviously a fairly low threshold which I don't think has been increased for years that's why it looks seems kind of ridiculously low. So this is calculated using the schedule SE so form 1040 so half of your self-employment tax can be deducted from your gross income on your form 1040 which can reduce your taxable income. So now you're probably saying like what? So you're telling me I have to pay income taxes which is going to be reported by going to the bottom line of the schedule C net income flowing into the first page or eventually to the first page of the form 1040 I pay income taxes on that and you're going to calculate self-employment taxes that we'll talk about but then I get to deduct half of the self-employment tax. Where do I get to deduct half the self-employment tax? Do I deduct it on the schedule C as a business deduction? And the answer is no because if you deducted it on the schedule C it would have an impact on net income which is what the self-employment taxes calculated on making a circle reference. So you have to deduct it somewhere else so it's going to be an above the line or adjustment to income. We'll see a tax software example of this in the next presentation but just to touch on again there's a lot of kind of components that are changed even with a fairly basic schedule C. So home office deduction just to note if you use part of your home exclusively for business you may be eligible to claim the home office deduction which can reduce your taxable income. Oftentimes small businesses work from home and so that's just going to add another level of complexity to calculate the expenses for the home office because normally if your home is a personal expense not deductible for taxes except we have exceptions for that like the mortgage interest for some reason basically just to prop up the housing industry got that I think that's the original reason that happened but normally you don't get to deduct the home but if you use your office for home then you might be able to deduct some of the home office expenses like utilities possibly and part of the mortgage interest might go then to the home office and the schedule A one and or the other you have to split them between the two in some way shape or form and you might even have depreciation and so on which we'll talk about again at a later point. So quarterly estimated taxes so since taxes are not withheld from your business income as a sole proprietor you may need to make quarterly estimated tax payments to cover your income tax and self employment tax liabilities. So in other words this is where a lot of people get into trouble because they're W2 employees they've been trained not to think about taxes it's not even my responsibility the employer does it everything happens automatically but when you go from a W2 employee to a sole proprietor you have to pay your own taxes and actually painfully write that check or you know do the electronic transfer these days to the government and you have to do it during the year not at the end of the year which means you don't even know how much tax you owe especially if you're a new business because you might not even be making money right you might have a loss so so you might not know how much you owe but if you do make money the IRS wants the money as you earn it you can't just wait till the end of the year and pay them why not because they hit you with the sticks of penalties and interest not physically metaphoric sticks penalties and interest they still hurt they still hurt okay so then so you try to avoid that by paying them taxes now again you might say well how much do I pay them what's my tax rate well I don't know it's progressive it's a progressive tax rate so we don't know so what if I made like 10,000 in the first month or something do I pay them like there wouldn't be any tax because that's below the progressive tax threshold possibly I might not owe any tax it well no you have to average the how much you're gonna make for the entire year so that you can properly calculate what the average tax would be on your yearly income rather than on like your monthly incomes like what I don't know how much I'm gonna make that's the problem right so that's why this is why the progressive tax system being more and more complicated does cause problems and probably decreases the the gross GDP because again it's uncertainty we don't know we can't really tell what's going on so that's that's the game we kind of have to play figure out how much you're gonna pay try to overpay a little bit to avoid getting hit with the sticks of penalties and interest so use form 1040 ES to calculate and pay these estimated taxes additional considerations depending on your business type and location you may be subject to other taxes or reporting requirements such as sales tax or local business taxes so remember we're talking here about the federal income tax and we tacked on to that