They say that nothing in life is permanent. But if anything that comes permanently with adulthood is filing our taxes. Taxes are an imperative part of our existence and are what little we can do to help our country grow. However, taxes vary on the type of employment you are into. Taxes for employers and self-employed individuals differ massively.
As a self-employed individual, it is important to know how to calculate your self-employment tax. This tax is used to fund Social Security and Medicare, and failure to pay can result in penalties. However, it is evident that self-employed individuals don't have an employer to withhold taxes from their paycheck. Instead, they are responsible for calculating and remitting their self-employment tax, which can be a daunting task. Still, it's important to understand the ins and outs of this tax to avoid penalties and interest. In this guide, we'll walk you through everything you need to know about self-employment tax.
So whether you're just starting as a self-employed individual or looking for ways to reduce your taxable income, read on for tips and advice on how to pay your self-employment taxes.
What Is Self-Employment Tax?
When you work for someone else, your employer is responsible for calculating and paying your income taxes. But if you're self-employed, you must calculate and pay your own taxes. This is called the self-employment tax, consisting of Social Security and Medicare taxes.
To calculate your self-employment tax, you must start by
- Determining your net profit or loss from your business. This is your gross income from the business minus any business expenses. Once you have your net profit or loss, you apply a self-employment tax rate of 15.3% to this amount. So if your net profit from the business is $10,000, your self-employment tax would be $1,530.
- You would then pay this and your other income taxes when you file your return. It's important to note that even if you don't owe any other income taxes, you're still required to pay the self-employment tax if your net profit from the business is over $400.
While it may seem like a lot, the self-employment tax helps ensure you have coverage under Social Security and Medicare. Therefore, self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners. The self-employment tax rate for 2019 is 15.3%. The rate consists of 12.4% for Social Security and 2.9% for Medicare. The Medicare portion of the tax has no income limit like the Social Security tax.
Who Is Subject To Self-Employment Tax?
The Social Security Administration (SSA) imposes the self-employment tax on certain individuals who work for themselves. This tax is used to fund Social Security and Medicare and is calculated based on the individual's net earnings from self-employment.
There are a few different ways to calculate self-employment tax, but the most common method is to take the individual's total net earnings from self-employment and multiply them by the Social Security tax rate (12.4%).
For example, if an individual has net earnings of $50,000 from self-employment, their self-employment tax liability would be $6,200 (($50,000 x 12.4%)).
The self-employment tax is generally imposed on individuals "engaged in a trade or business." People who are subject to self-employment taxes are:
- Sole proprietor
- Those who own a single-member LLC
- Independent contractors
- Those who are under any form of legal business partnership, and
- Those who carry operational membership in a partnership LLC
However, there are a few exceptions to this rule. Like,
- Certain types of income, such as interest or capital gains, are not subject to self-employment tax.
- Additionally, individuals considered to be "statutory employees" are not subject to the tax. Statutory employees are those treated as employees for tax purposes but would not otherwise be considered employees under the common law rules.
- Finally, individuals considered "self-employed" for Social Security purposes are not subject to the self-employment tax.
Self-employed individuals for Social Security purposes include those who work in a trade or business and file Schedule C or Schedule F on their tax return. If you have net earnings from self-employment of $400 or more, you usually have to pay self-employment tax. Net earnings generally are the amount left after subtracting business expenses from business income. This amount is reported on Schedule C (Form 1040), Profit or Loss From Business, or Schedule F (Form 1040), Profit or Loss From Farming.
How Is Self-Employment Tax Different Than Income Tax?
The self-employment tax is not an income tax. Instead, the Social Security Administration uses the money collected from the self-employment tax to pay benefits to retirees and their families, people with disabilities, and survivors of deceased workers.
- You figure out the amount of self-employment tax you owe by using Schedule SE (Form 1040).
- After you have figured out your net earnings from self-employment, you multiply that amount by 92.35% (92.35% = 100% - 7.65%, the OASDI tax rate for 2019). This gives you the social security wages subject to tax.
- You then multiply that amount by the 12.4% Social Security tax rate.
- You also have to pay Medicare taxes on all your net self-employment earnings. The Medicare tax rate is 2.9%. There is no wage base limit for Medicare taxes. So you figure the Medicare tax you owe by multiplying your net earnings from self-employment by 2.9%.
You may owe additional taxes, such as state income tax if any apply.
Self-employment tax is only one of several types of taxes you may have to pay as a small business owner or self-employed individual. Other possible taxes include:
- Federal, state, and local income taxes.
- Federal and state unemployment taxes.
- Excise taxes.
You may visit the IRS website for more information on small business taxes.
How To Calculate Self-Employment Tax?
Self-employment tax is a tax imposed on those who work for themselves. The tax is used to fund Social Security and Medicare and is calculated based on your net income from self-employment. But how exactly calculate net earnings? Here's how to do this.
Calculate Net Earnings
To calculate your self-employment tax, here is what needs to be done.
- You will first need to determine your net income from self-employment.
- This can be done by subtracting your business expenses from your total income.
The formula is: Net Earnings = Gross Business Income - Total
- Once you have your net income, you must multiply it by the self-employment tax rate.
For example: For the 2020 tax year, the self-employment tax rate is 15.3%. Therefore, if your net income from self-employment is $10,000, your self-employment tax liability would be $1,530.
Note: It's important to note that you are only responsible for paying self-employment tax on the first $137,700 of your net income. Any amount over that is not subject to self-employment tax. You may also be able to deduct your self-employment taxes from your overall taxes owed.
Understand The Self-Employment Tax Rate
Self-employment tax is a Social Security and Medicare tax principally for individuals who work for themselves. It is also levied on some partners in partnerships and some shareholders in small corporations. Here are certain things to be noted.
- The Medicare portion of the tax is 2.9% (1.45% each for employee and employer portions).
- The Social Security portion is 12.4% (6.2% each for employee and employer portions).
- There is no employer contribution for the self-employed, hence the "self" employment tax moniker.
- The combined Medicare and Social Security tax rate for self-employed individuals is 15.3%.
Congress imposes this tax to fund these social programs. It functions similarly to the FICA taxes withheld from the pay of wage earners. When you work for someone else, your employer withholds half of your FICA taxes from your paycheck and pays the other half directly to the government. As a self-employed individual, you must pay the entire 15.3% yourself.
However, because it is considered an income tax deduction, you effectively only pay approximately 10%. So, to begin with, you basically start by:
- You figuring out your self-employment tax by using IRS Form 1040 Schedule SE. This document also calculates your income tax liability based on your business net earnings. Your business net earnings are your gross receipts minus your business expenses incurred while generating those receipts. Therefore, if your business earned $100,000 in gross receipts but it cost you $70,000 to earn that income, your net earnings would be $30,000 ($100,000 - $70,000).
- Based on a net earning of $30,000 and the current SE tax rates detailed above, you would owe $4,590 in self-employment taxes ($30,000 x .1535 = $4,590). Because this amount represents a deduction for income taxes, you would only pay approximately $3,072 after considering this deduction ($4,590 x .75 = $3,442).
The good news is that once you've calculated your self-employed tax liability and sent in your payment to the IRS (or had it deducted from any federal income tax refund due to you), you're done dealing with this issue until next year's tax filing season rolls around again!
Apply The Tax Rate To Net Earnings
The Self-Employment Contributions Act (SECA) tax is a Social Security and Medicare tax primarily for individuals who work for themselves. The SECA tax is also imposed on partnerships and shareholders who own more than 2% of the business.
The current SECA tax rate is 15.3%. This tax rate consists of two parts:
- 12.4% for Social Security (old-age, survivors, and disability insurance), and
- 2.9% Medicare (hospital insurance)
Notably, applying the tax rate to net earnings is a simple process that anyone can do with little practice.
- The first step is to determine your net earnings. This is the amount of money you earned after all deductions have been made.
- Once you have your net earnings, you will multiply that number by 15.3%. This is the tax rate that you will use to calculate your taxes.
- You will simply multiply your net earnings by the tax rate to get the final amount.
The formula is: *SECA = Net Earnings 15.3% **
For example: If your net earnings are $100, then the calculation will be:
SECA= $100 X 15.3% = $15.30 is the tax owed
Applying the tax rate to net earnings is a quick and easy way to calculate your taxes owed for the year.
Social Security Earnings Exception
The Social Security earnings exception is a special rule that allows certain benefit recipients to continue to receive benefits even if their earnings exceed the program's limit. The exception applies to disabled adults who are working and receiving Social Security Disability Insurance (SSDI) benefits and to blind adults who are working and receiving Supplemental Security Income (SSI) benefits.
In order to qualify for the exception, beneficiaries must be working in what is known as a "Trial Work Period." This period allows them to test their ability to work while still receiving benefits. If they are able to work and earn enough money during the trial period, they can continue to receive benefits even after their earnings exceed the program's limit. The Social Security earnings exception is a valuable tool that helps disabled adults transition into the workforce. By allowing them to keep their benefits while they test their ability to work, the exception provides much-needed financial security during a time of transition.
How Fincent Helps to Calculate Your Self-Employment Tax?
How to calculate your self-employment tax is a frequently googled question, and the answer to this, especially to small business owners, can be arcane. However, worries can be put to aid with Fincent.
Fincent understands how imperative it is to stay on top of your taxes without amiss, and that's exactly where our cloud-based financial innovations come in. Fincent aims to make business finances effortless for you. From bookkeeping to filing your taxes, we aim to aid you in making business decisions that help you thrive so that there's no looking back! Here is how you can best utilize Fincent to calculate your self-employment tax.
- Profit And Loss Calculation
The first step in understanding your business' taxes is to get a grip on your overall profitability. Fortunately, with Fincent this is an easy task. With its Profit and Loss Report, you can get detailed insights into your sales, costs, and profits for any given period of time. This report will help you better understand your business's overall financial picture and make informed decisions about your self-employment tax liability.
- Expense Calculation
Once you understand your business' profitability well, it's time to start thinking about your deductible expenses. With Fincent, calculating your deductible expenses is simple and straightforward. With our Expense Tracking feature, you can easily track and categorize your business expenses in one place. This information will be automatically populated into our Tax Preparation feature, making it easy for you to calculate your self-employment tax liability.
- Deductions Calculation
In addition to tracking your deductible expenses, you may also be able to take advantage of certain deductions that can reduce your self-employment tax liability. The most common deduction for self-employed individuals is the home office deduction. If you use a portion of your home for business purposes, you may be able to deduct a portion of your mortgage interest, property taxes, and other eligible expenses. To calculate your home office deduction, simply enter your information, and we'll do the rest.
- Estimated Tax Payment Calculation
Once you understand your business' profitability and deductible expenses, it's time to start thinking about making estimated tax payments. Estimated tax payments are made quarterly and are used to pay your self-employment tax liability. With Fincent, calculating your estimated tax liability is simple. Simply use our self-employment calculator to calculate the estimated amount of self-employment tax you need to pay every quarter.
- Record Keeping
One of the most important aspects of calculating your self-employment tax liability is keeping accurate and up-to-date records. With Fincent’s Record Keeping feature, you can easily track and categorize all of your business income and expenses in one place. This information will be automatically populated into our Tax Preparation feature, making it easy for you to calculate your self-employment tax liability.
- Year-End Procedures
As the end of the year approaches, there are a few things you'll need to do to prepare for the upcoming tax season. First, you'll need to gather your relevant tax documents, including your profit and loss statements, expense reports, and records of estimated tax payments. Next, you'll need to calculate your self-employment tax liability for the year. This can be done by entering your information into our Self-Employment Tax Calculator. Perhaps, filing taxes last minute is a thing of the past. With Fincent, track, record, and file taxes at-a-go! Be it the year-end or on a quarterly basis, Fincent will take care of it all.
How To Pay Self-Employment Tax?
Now that you understand how to calculate your self-employment tax liability, it's time to start thinking about how to pay it. The good news is that a few different options are available to you.
- The first option is to pay your self-employment tax liability with your personal income tax return. When you file your personal income tax return, you'll simply include your self-employment tax liability as part of your overall tax liability. This option is typically best for those who expect to owe less than $1,000 in self-employment taxes for the year.
- The second option is to make estimated tax payments throughout the year. Estimated tax payments are typically made on a quarterly basis and can be made online, by mail, or by phone. To make an estimated tax payment, you'll need to complete and submit Form 1040-ES. This option is typically best for those who expect to owe more than $1,000 in self-employment taxes for the year.
- The third option is to pay your self-employment tax liability with a credit card. While there are a few different ways to do this, the most common method is to use a service like payUSAtax.com. This option is typically best for those who need to make a one-time payment or who want to earn rewards points on their payment.
Tax Deductions And Tax Credits For Self-Employment
As a self-employed individual, you may be eligible for certain tax deductions and tax credits. These deductions and credits can help reduce your overall tax liability and, in some cases, even increase your refund. Some of the most common deductions and credits available to self-employed individuals include:
- The home office deduction
- The self-employment health insurance deduction
- The SEP IRA contribution deduction
- The self-employment retirement plan contribution deduction
Taking advantage of these deductions and credits can reduce your tax liability and keep more of your hard-earned money.
Effects Of Self-Employment Taxes On Your Personal Tax
If you're self-employed, you're responsible for paying the employee and employer portions of your Social Security and Medicare taxes. This can have a significant impact on your overall tax liability.
For example, if you're in the 25% tax bracket, you'll owe an additional 6.2% in Social Security taxes and 2.9% in Medicare taxes on your self-employment income. In addition, your self-employment income will be subject to federal and state income taxes. The amount of tax you owe will depend on your tax bracket and the amount of self-employment income you earn.
What Impact Does Business Type Have On Your Self-Employment Earnings?
The type of business you operate can significantly impact your self-employment earnings. For example, if you're a sole proprietor, you'll only be responsible for paying the employee portion of your Social Security and Medicare taxes. However, if you're a partnership or an S corporation, you'll be responsible for paying the employer portion of your Social Security and Medicare taxes in addition to the employee portion. The amount of tax you owe will also depend on the type of business you operate.
For example, sole proprietorships and partnerships are subject to federal and state income taxes, while S corporations are only subject to federal income taxes. As a self-employed individual, it's important to understand how self-employment taxes can impact your overall tax liability. By understanding how these taxes work, you can make sure you're prepared when tax time comes around.
Self-employment taxes can be complex. However, understanding how these taxes work can minimize your tax liability and maximize your refund is crucial. If you have questions about self-employment taxes or your personal tax situation, please contact a tax professional. You can also visit fincent.com for your finance needs. Our cloud-based technology brings directives to your business finances, helping you scale through bookkeeping, filing your taxes, tracking expenses, collecting and making payments, and much more.
Fincent: Your Business's Personal Financial Wizard - From Bookkeeping to Tax Filing