Self-employment is part of the American dream for many. To do what you love and get paid for it can be incredibly rewarding if handled properly. However, one of the factors that needs to be considered is self-employment tax — which is a necessary evil when you are doing what you love!
Benjamin Franklin, whose face graces the U.S. hundred-dollar bill, once said, “In this world nothing can be said to be certain, except death and taxes.” While taxes may be a certain part of doing business and working, you may not be so certain about how to properly account for those taxes if you are self-employed.
Read on to learn more about self-employment tax.
What is self-employment tax, and who pays it?
What is it? The Self-Employment Contributions Act (SECA) is the 1954 law that governs the payment of all taxes that relate to folks who work for themselves. In addition to the general income tax, SECA tax payments account for the Social Security and Medicare portions of your tax burden.
Who pays it? Any person who works for themself as a sole proprietor, independent contractor, partner, or member of an LLC will have self-employment or SECA tax payments apply to the net income generated by their work and business.
Revenue requirements? Specifically, if you earn more than $400 from your business (or $108.28 as a church employee), you must pay self-employment taxes.
Deductions? Most people who are employees of another company may see taxes as an automatic deduction, but the process for self-employed individuals is different. It’s the responsibility (and burden) of those who work for themselves to do all the accounting related to their taxes (e.g., withholding, payment, annual deduction).
How does self-employment tax work?
In a self-employment situation, you, the business owner, essentially function as both employer and employee. This means that you have to consider both roles when handling your taxes.
- As an employer, you’re responsible for paying the employer portion of taxes from your business’s gross revenue. This includes both Social Security and Medicare taxes. Before you pay yourself anything out of what you earn from your business, you need to consider the applicable taxes and pay them accordingly. Thankfully, this employer tax portion can be considered a deduction from your overall tax burden.
- As an employee, you again owe a portion of Social Security and Medicare taxes. You must make sure you’ve paid the right tax payment at the end of the year, and you’ll have to figure that out without having it automatically deducted from your paycheck (which is the case for most employees).
[RELATED ARTICLE: Social Security Wage Base: What You Need to Know ]
Important! Note that the employee portion of Social Security and Medicare taxes cannot be used as a deduction. This is why it’s important to account separately for the employer and employee portions of the taxes.
What does the IRS require?
Schedule SE form. You’ll want to use the Schedule SE form to calculate the amount you owe in self-employment tax. This updated form provided by the IRS will guide you through all the necessary calculations to figure out how much you owe.
Estimated tax payments. It’s not necessary (or advisable) to wait until the end of the tax year to account for your self-employment tax burden, by the way. Estimated tax payments, made by filing the regular Form 1040-ES, are a wise move in order to avoid a lump-sum payment at the end of the year, as well as for avoiding penalties for waiting until the end of the year.
How much do I have to pay?
The amount of self-employment tax you owe depends on the type of tax you’re paying. As of the 2017 tax season, Social Security taxes only have to be calculated based on the first $127,200 of revenue generated by the business. In 2018, Social Security taxes apply to the first $128,400 earned. No additional taxes should be taken out if your business’s revenue goes above this limit.
Medicare is different, though, in that there’s no limit to the amount that can be paid. The Medicare tax takes all income and wages into account and should amount to 3.8% of all net earnings (depending on wage base and marital status).
Doing taxes correctly can be an onerous task, but since they have to be done, it’s necessary and extremely wise to do them correctly. The alternatives (e.g., fees, legal consultations, and added stress and work) are far worse than spending a bit of extra time at the outset to complete your required self-employment tax filing and payment. So download those forms and get to work!
If you’re looking for an easy way to calculate your payroll tax liability, look no further. Try Patriot Software’s payroll for one employee. This online payroll software is perfect for solopreneurs looking to keep costs down. Try it free today!
This article has been updated from its original publication date of January 29, 2015.This is not intended as legal advice; for more information, please click here.