The self-employment tax rate for 2006 is 15.3% of the first $94,200 of income and 2.9% of everything over $94,200. Partners report their self-employment taxes on Schedule SE, which they submit annually with their personal income tax returns.

Expenses and Deductions

You may be wondering how you will survive financially, after paying income taxes, Social Security taxes, and Medicare taxes on your share of business income, even if you don't withdraw it out from your business. Luckily, you don't have to pay taxes on most of the money your business spends to make a buck.

You and your partners can deduct your legitimate business expenses from your business income, which will greatly lower the profits you have to report to the IRS. Deductible expenses include start-up costs, operating expenses, travel costs, and product and advertising outlays, as well as a portion of the money you spend on business-related meals and entertainment.

Incorporating Your Business May Cut Your Tax Bill

Unlike a partnership, a corporation pays its own taxes on all corporate profits left in the business. Owners of corporations pay income taxes only on money they receive as compensation for services (salaries and bonuses) or as dividends.

While many small businesses would rather not file a corporate tax return, incorporating can offer business owners a tax advantage over a partnership's "pass through" taxation. This is especially true for businesses that expect to retain profits in the business from year to year.

If you need to keep profits (called "retained earnings") in your business, you may benefit from lower corporate tax rates, at least for the first $50,000 - $75,000 of profits per year. For example, if your retail outfit needs to stock up on expensive inventory, you might decide to leave $30,000 in your business at the end of a year. If you operate as a partnership, these retained profits will likely be taxed at your marginal individual tax rate, which is probably more than 25%. But if you incorporate, that $30,000 will be taxed at a lower 15% corporate rate.