It wasn't entirely clear from this article, but it looks like he was paying normal income tax on the money coming in, but failed to pay self-employment taxes. I have talked to more than a few iPhone developers whom this happened to as well -- forgetting about that extra 15.3% can really hurt.
But, did he remember to track and deduct all of his expenses? The flipside to that income is that the server costs are all deducted from it. If he really was "just barely covering costs" with his Google ads income, it should be 15.3% of nearly zero dollars. He may even be owed a refund if he was paying full income tax on the ad revenue without deducting server costs.
I am not an accountant, but I've dealt with SE tax and had a few "conversations" with the IRS in the past. For all the worries about them being biased, I've found them to be fair, as long as you have precise documentation.
Agree the article is very vague on what he was doing when filing. Most likely he was not paying the self-employment taxes and get audited; however, like you said, he should have been deducting expenses. I am not an accountant or tax attorney, but I believe in this case, as long as he kept detailed records he can go back and refile. They may ask him for receipts and documentation, but that should be fairly easy to acquire from his hosting company. I have had to refile my tax return for a previous year, it was not part of an audit, just missed a 1099 and didn't realize it until the following year. My accountant took care of refiling and ended up getting a larger refund.
Well that is what I don't understand about the article, sure unless you are a S-corp you are going to get nailed for FICA and even if you are you don't totally duck them. By my issue with the article is; great you are now a company, you just got a ticket to take a boat load of new deductions, write-offs and depreciations. If he was just skirting by, he should be able to prove this via deductions which should more than offset the mandatory FICA portion. I mean if he is spending that much it should not be that hard to shave off 8% in deductions.
It seems pretty clear by the article that he wasn't doing any of the "business" things like tracking deductions or documentation of any kind. He could probably muster up his hosting and domain name bills but that would be it, and probably the majority of any deduction he could take anyway (recognizing his library and other "support" items as deductible as well).
It seems crazy to me that it's even possible to accidentally pay "payroll" taxes on your income an not pay the extra self-employment tax. If you use any kind of tax preparation software, it's completely calculated for you. You just enter 1099s and W2s and everything comes together.
I think you're confused. "Payroll tax" and "self-employment tax" are both informal ways to refer to the employers portion of social security tax (FICA). It sounds like this guy was paying income tax on it, but not social security or medicare (which is about 15% total for self-employed).
This is an entirely reasonable mistake because that is the correct way to do taxes on unearned income like interest. Only earned income is subject to social security and medicare.
Theoretically, your employer pays half the employment taxes and you pay the other half. When you are self-employed you must pay all of them. Of course, this simply equates to W2 employees being paid less income.
There's a (roughly) 15% tax on income that covers social security and medicare. As an employee, 7.5% of this comes out of your paycheck, and your employer has to match the other 7.5%. When you're self-employed, you need to pay both ends of this (unless you start getting tricky with the way you incorporate)
But, did he remember to track and deduct all of his expenses? The flipside to that income is that the server costs are all deducted from it. If he really was "just barely covering costs" with his Google ads income, it should be 15.3% of nearly zero dollars. He may even be owed a refund if he was paying full income tax on the ad revenue without deducting server costs.
I am not an accountant, but I've dealt with SE tax and had a few "conversations" with the IRS in the past. For all the worries about them being biased, I've found them to be fair, as long as you have precise documentation.