Self Employment Tax by r5uhfBp

VIEWS: 6 PAGES: 3

									Self Employment Tax

Tax year 2008 was the first year I had any self employment income to speak of. It was also my
first introduction to the self employment tax. When you work for an employer, you split the
tax rate for social security and Medicare. But when you are in business for yourself you pay
both sides of the equation – 15.3% (12.4% for social security and 2.9% for Medicare). It may
not seem like much, but the self employment tax rate paid on top of your normal income tax
rate can make for a large tax liability.

Estimated Tax Payments

Speaking of large tax liabilities, if you plan to have to pay more than $1,000 or so in self
employment taxes, it is a good idea to make estimated tax payments on a quarterly basis to
avoid underpayment penalties. Think of this as you withholding from your own income, similar
to the way companies withhold tax payments from an employee’s paycheck.

Estimated tax payments may be made free online using the EFTPS (Electronic Federal Tax
Payment System). Once your enroll at the site you are mailed a PIN to the address on record
with the IRS. The pin takes a couple weeks to arrive, so plan accordingly. Once you have the
PIN you may create an online profile/password at EFTPS and you are on your way.

To simplify things a bit, I set aside 30% of my self employment income (freelance writing, ad
sales, etc.) in a sinking fund at one of our designated online banks. When the time comes to
make quarterly estimates, I simply transfer money from my “Taxes” sinking fund using the
EFTPS.

*Note, 30% may be too high or too low for your specific situation. It’s a good idea to review last
year’s taxes and determine your tax liability for self employment income to come up with a
starting amount due for this year. Be sure to increase or decrease that amount based on your
revenues.

Improve Your Record-Keeping System

A good record-keeping system is vital to the success of any entrepreneurial venture. After all,
without tracking profits and losses, how do you even know if what you are doing is worth the
effort? It is also a big help around tax season. Even if all you do is create a file folder labeled
“2009 Taxes” and toss all receipts and income statements there, it’s a start.

Those of us with self employment income have legitimate opportunities to deduct expenses
from our income. Use only those that apply to you, and be sure to keep up with your receipts
throughout the year to prove the expenses were paid.

Consider Hiring a Professional

Don’t take my word for it, consider consulting a tax professional, particularly when things get
complicated. A CPA, or someone specializing in taxes for small businesses, will help guide you
through filing the appropriate forms, help determine which expenses are deductible from your
income, and help you avoid any potential audit red flags. I am a do-it-yourselfer by nature, but
readily admit I will pay for tax advice when necessary. Considering the consequences of an
audit, penalties, etc, it might be the most frugal thing you could do.

How to Calculate Self-Employment Tax

1.      Step 1

     Figure out your net income from self-employment. Net income is typically your total
     business receipts minus your total business deductions.

2.      Step 2

     Multiply your net income from self-employment by 0.9235 (or 92.35 percent). Your answer
     is called your "net earnings" from self-employment. If this number is less than $400, you
     don't have to pay self-employment tax.

3.      Step 3

     Multiply the amount of your net earnings that is $76,200 or less by 0.153 (or 15.3 percent),
     and multiply any net earnings over $76,200 by 0.029 (or 2.9 percent). Add your two
     answers together. This is your self-employment tax.

4.      Step 4

     Factor in your deductions. You can deduct half of your self-employment tax in determining
     your adjusted gross income. Do this in the Adjustments section of the 1040. Interest,
     dividends, capital gains, rental income, pensions and other forms of unearned income are
     not subject to self-employment tax.

5.      Step 5

     Report your self-employment tax on Schedule SE of the 1040.



To help explain what the self employment tax is you need to understand what taxes are paid on
your behalf when you work for someone else. The taxes that would normally be taken out of
your check by your employer include both the federal withholding tax and FICA. The tax we’re
concerned with here is the FICA tax. Normally this tax is 7.65% of your gross income. The tax is
actually two separate taxes. One is your Social Security tax with a tax rate of 6.2%. The other
goes to Medicare and the tax rate for it is 1.45%. Combined you have your 7.65% tax rate.

Now the federal withholding and FICA taxes are normally withheld by your employer and sent
to the IRS. But the actual rate paid to the IRS for the FICA tax is not 7.65%. That is just the
portion that is withheld from your paycheck. The actual FICA rate that is paid is 15.3%. The
7.65% you pay on your gross wages has to be matched by your employer and is then applied to
your account. So if you had $100.00 withheld for the FICA tax by your employer then they have
to match that money with an additional $100.00. If you are the employer this can eventually
become a very large amount of money that you will be responsible for paying.

So if you are considered self employed the self employment tax you are paying is the matching
portion of your FICA taxes. Since the taxes must be paid and you are considered your own
employer you are responsible for paying the tax yourself. The government will always want its
money regardless of where they get it.

If you are an entrepreneur and own a small business then there is no real way of getting around
this tax. Even if you file W-2’s for yourself and your employees you will still pay this tax on
yourself. It will just change from being a self employment tax back to a matching FICA tax.
Either way it will come out of your pocket. It’s just one small price you will have to pay to be
your own boss

								
To top