What is Self-Employment Tax?
You have left behind the comfort and familiarity of a regular job and decided to make the leap in becoming self-employed. Anyone who starts their own business has to file taxes as a self-employed worker. Alternatively, not filing taxes and seeing your taxes bill blow up over the years, is not pretty. So, if you are wondering what you need to do to file your taxes with the IRS successfully, let us discuss what self-employment tax is first.
According to the IRS website, self-employment tax is defined as “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.”
Workers who are considered sole proprietors, freelancers, or independent contractors who carry on a trade or business are considered self-employed and must pay the self-employment tax. Self-employment tax is due when an individual has net earnings of $400 or more in self-employment income over the course of the tax year.
Many newly self-employed people find themselves surprised at their tax bills at the end of the year because they notice they’re suddenly paying a lot more in taxes as a self-employed person than as an employee. This is because they’re carrying the full responsibility of paying for their Social Security and Medicare, but when you’re an employee, you share that cost with your employer.
The self-employment tax rate consists of two parts: 12.4% for social security and 2.9% for Medicare – totaling to 15.3%. For 2020, Social Security part of the tax applies to the first $137,700 of earnings. If you earn more than that, then the 12.4% part of the tax that pays for the Social security stops for the year. For the Medicare portion of the self-employment tax, no matter how much you earn, you’ll pay the 2.9% Medicare Tax. (There is an additional Medicare tax when you pass a certain threshold, it is an additional .9% and the threshold is different, depending on filing status. To learn more click here.)
By now, you have probably heard of the Form 1040 and might be wondering what the heck it is. The Form 1040 is the standard IRS form that individual taxpayers use to file their annual income tax returns. The form contains sections that require taxpayers to disclose their taxable income for the year to determine whether additional taxes are owed or whether the filer will receive a tax refund.
As a self-employed individual, you’ll need to file the Form 1040 with the IRS by April 15 in most years. Everyone who earns income over a certain threshold must file an income tax return with the IRS.
In order to report the self-employment tax, you must report the results of your operations on Schedule C, essentially your business’ profit and loss statement, and file it with your Form 1040. Luckily, all pages of Form 1040 are available on the IRS website and it can be mailed or e-filed. It is also important to understand that there are also different types of Form 1040 – such as the 1040-SR, 1040-NR, 1040X, and many others.
Steps to estimate self-employment tax if you are a simple filer:
Calculate how much of your net income is taxable. Multiply your total self-employment net income by 92.35% (.9235) – this is the percentage of your income the IRS says is taxable
Calculate the amount you owe for self-employment taxes. Multiply your total self-employed taxable income by 15.3%
Report half of your self-employment tax as an adjustment to income on form 1040. Your total SE tax is reported on Form 1040 in the “Other Taxes” section. 50% of self-employment tax owed can be claimed as a deduction. This reduces your adjusted gross income and the amount of income tax you owe.
Finding the right accountant that fits your needs doesn’t have to be difficult. Arias, Arias & Jasko Financial has assisted clients with self-employment tax services. With the help of Arias, Arias & Jasko Financial, we can help you reach your business goals and set you on the right path. You can’t skip accounting, but you CAN make it easier!
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