If you work for yourself you may think that you are exempt from paying taxes that most employees have deducted from their regular paychecks. While we hate to be the bearer of bad news, if this is the case, you should think again.
Meet Self-Employment Tax
Self-employment tax is similar to the Social Security and Medicare taxes (FICA) withheld from the pay of most company employees.
One main difference, however, is that for employees, these taxes are figured and determined by their employers (and then withheld from that employee’s paycheck) while if you are self-employed, you calculate the self-employment tax (SE tax) yourself using Schedule SE (Form 1040).
Many new sole proprietors, independent contractors and consultants are surprised to learn that they pay a lot more in taxes as a self-employed person! This is because those who are self-employed are required to pay the full amount of their Social Security and Medicare tax, which is typically split between traditional employees and their employer.
It’s not all bad news, though. Self-employed taxpayers can claim a federal deduction for half the SE tax that they pay, which will lower the net amount paid. Employees do not have this option.
Who must pay self-employment tax?
You must pay self-employment tax and file Schedule SE (Form 1040) if any of the following apply:
- Your net earnings from self-employment were $400 or more.
- If you received income from a partnership (Schedule K-1).
- or if income on your 1099-Misc was reported as self-employment income, Box 7.
Other points to keep in mind:
- SE taxes and income taxes are two separate taxes – meaning that you can owe self-employment tax even if you don’t need to pay income tax
- The SE tax rules apply no matter how old you are, and even if you are already receiving Social Security or Medicare benefits;
- Special IRS rules for SE taxes apply to workers who perform in-home services for elderly or disabled individuals (caregivers). More on this in an upcoming article.
What are the components of the SE tax, and exactly how is it calculated?
There are three parts of the SE tax that individuals must pay:
- As of 2015, a 12.4 percent Social Security tax applied to the first $113,700 of net profit or earnings from self-employment.Note: If you have earnings above this dollar limit (from self-employment or, if you also have a job, from the combined earnings from your job and your business), then the earnings above this dollar limit are not subject to this 12.4 percent tax.
- A 2.9% Medicare tax applied to all earnings from self-employment and all wages from traditional employments.Note: there is no earnings limit like there is for the 12.4 percent tax.
- An additional .9 percent Medicare tax applied to income from self-employment and/or wages that exceed $200,000 for single filers and $250,000 for married filers.
Doing the math
When figuring self-employment tax you owe, you reduce your self-employment income by half of the SE tax before applying the applicable tax rate. You also claim 50 percent of what you pay in self-employment tax as an adjustment to income, which is allowed on the front of your Form 1040.
To get a quick look at what your Self-Employment taxes might be, you can use a handy self-employment tax calculator. But to get a better understanding of your tax liabilities as well as to create comprehensive tax plan, contact Sousa & Weber, LLP. We are tax experts who have helped hundreds of self-employed workers understand their tax obligations.
Contact us today.