When you work as someone who is self-employed, one of the costs of doing business is paying the self-employment tax. As you get ready to pay your taxes, don’t forget that you will need to add the self-employment tax.
What is the Self-Employment Tax, and Who Must Pay It?
The self-employment tax encompasses Medicare and Social Security taxes. For those who are more traditionally employed, these taxes are automatically taken out of the paycheck. The employer pays a portion of the tax, and the employee pays a portion.
Note that as a self-employed person, you will be responsible for the entire tax on your own — both the employer portion and the employee portion.
The IRS expects you to pay self-employment tax if:
- Your net earnings from your self-employed activities are $400 or more during the tax year, OR
- Your church employee income is $108.28 or more.
Understand that you are required to pay self-employment tax no matter your age, and even if you are already receiving Medicare and/or Social Security benefits.
Remember that even if you make less than $400 from your activities, the IRS still expects you to report your income. You should also be aware that many of those who issue 1099 forms won’t do so unless they have paid you $600 or more during the tax year. So, even though you may not receive a 1099, it doesn’t mean that you shouldn’t report the income. The IRS expects you to.
Paying Self-Employment Tax
You pay your self-employment tax when you pay the rest of your taxes. Self-employment tax is reported on your Form 1040. You can use Schedule C to figure out your net earnings if you are a sole proprietorship or LLC, or you can use your business tax return to figure your net earnings if you are a S-Corp. In any case, once you know your net earnings, you can use Schedule SE to figure out how much you owe in self-employment tax.
Note that how you incorporate and how much you make will affect what you pay in self-employment tax. If you haven’t incorporated yet, make sure to weigh all the variables to see what will work best for your taxes.
The tax rate is subject to change, depending on inflation. For tax year 2011, the self-employment rate is 13.3%, which represents a 2% reduction from the 2010 rate, due to the 2010 Tax Relief Act which reduced payroll taxes. The move reduced the employee side of Social Security taxes, and for the self-employed, that reduction translated into a lower self-employment tax.
During the 2011 tax year, only the first $106,800 of your income is subject to the Social Security portion of the self-employment tax. Any income above that amount is not taxed for Social Security, which can be a welcome break for those that are self-employed.
Because the self-employment tax is in addition to the regular income tax, it can become a real burden if you don’t plan ahead for it.
When your taxes are figured each year, make sure that you also figure your estimated quarterly taxes. You can use this as a guide. Every quarter, you pay your estimated taxes, and it counts toward what you owe. This breaks down your tax liability into more manageable payments. Plus, it helps you avoid penalties. As a self-employed person, you are expected to make quarterly payments. If you don’t you will be assessed interest charges, and possibly other penalties.
In order to avoid penalties for underpaying over the course of the year, you should pay at least 90% of your tax amount from the previous year. This way, even if you owe a good deal more over the course of a new tax year, you will be protected from the penalties that come with owing a lot more.
Self-Employment Tax Deduction
You do receive a tax deduction for paying the self-employment tax.
This tax deduction is taken on the front part of your Form 1040, as you determine your adjusted gross income. The tax deduction amounts to half the amount of what you owe in self-employment tax.
So, before you fill out your Form 1040, you should first figure out your net earnings (remember there are ways to lower your self-employed income), and then fill out your Schedule SE. That way, as you fill out your Form 1040 and determine your tax deduction, you will be prepared.
It is also worth noting that if you get health insurance on an individual or family basis as part of the conditions of your self-employment, you can receive a tax deduction for the cost of your health insurance premiums. Both Form 1040 and Schedule SE include instructions for claiming your health insurance cost deduction as someone who is self-employed.
Bottom Line
As someone who is self-employed, you have a lot of costs that many traditionally employed people don’t have to pay. Be sure to plan for these costs — especially when it comes to paying the self-employment tax. You don’t want to end up in trouble for tax evasion, paying large penalties.
Thomas - Ways to Invest Money says
This is a great article. I remember when I first incorporated a business that was so much I was unaware of or just simply took for granted. You have to make sure you have all your documentation in order or you could end up paying for it later like I once day.
Elvis Fuller says
Self-employment tax is a tax consisting of Social Security and Medicare taxes 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.