What is Self-Employment Tax

What is Self-Employment Tax?

Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves as independent contractors. Independent contractors are considered a small business operate in the eyes of the IRS.  It is similar to the Social Security and Medicare taxes withheld from the pay of most W2 wage earners.

Social Security and Medicare taxes of most wage earners are figured by their employers. But independent contractors will have to figure that out using the SE form that is based on the profits of the company.  Also, you can deduct the employer-equivalent portion of your SE tax in figuring your adjusted gross income on your personal tax return. W2 Wage earners cannot deduct Social Security and Medicare taxes on their personal tax return.  This is an IRS rule for the self-employed worker only.  Now you what self-employment is we will discuss the amount of the tax.

Self-Employment Tax Rate.

The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

The amount for 2018 is $128,400. (For SE tax rates for a prior year, refer to the Schedule SE for that year). 

All your combined wages, tips, and net earnings in the current year are subject to any combination of the 2.9% Medicare part of Self-Employment tax and Social Security tax.

Who Must Pay Self-Employment Tax?

You must pay self-employment tax and file Schedule SE (Form 1040) if either of the following applies. 

  • Your net earnings from self-employment (excluding church employee income) were $400 or more.
  •  You had church employee income of $108.28 or more.

Generally, your net earnings from self-employment are subject to self-employment tax. If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C or C-EZ to figure net earnings from self-employment.

If you have earnings subject to self-employment tax, use Schedule SE to figure your net earnings from self-employment. Before you figure your net earnings, you generally need to figure your total earnings subject to self-employment tax. 

Making estimated tax payments.

Because there is no withholding, independent contractors or self-employed workers usually have to satisfy their tax obligations through the payment of estimated taxes, which may be unfamiliar to many workers. Estimated payments are made to cover federal tax obligations four times per year. From my experience over the years this is the biggest issue for sole proprietors acting as a small business operator. 

Each year they have a huge tax bite at the end of the year, and they do not have the funds to pay the tax liabilities. The big tax bite is do the self-employment taxes on the business profits.

Even more challenging than remembering to make estimated tax payments is having the cash on hand to pay them. Rather than spending all the money that comes in, it is highly advisable for an independent contractor worker to set aside a set percentage of earnings to create a fund for estimated tax payments. This can be done, for example, through a separate bank account.

Another strategy, if the worker has a spouse who is employed, is for the spouse to adjust to cover the estimated taxes of the gig worker (assuming the spouse is agreeable to this).

How does an independent contractor work track the salary earned? 

There are a couple of different ways to track the salary earned:

Form 1099 Miscellaneous (Form 1099 MISC) this form is given to the worker if the independent contractor is for an extended period.  For example, if you contract is for six months as a freelance programmer or photographer.

If you record the gig with an invoice to the person paying you then you can calculate the total revenue by taking a tally of all of the invoices that you got paid for during the year.

We’ve packaged all that expertise into a single company, so you don’t have to waste time and money coordinating those services, and the communication that is required between the experts that provide them. And by combining them, we’ve eliminated waste and created real efficiencies, which means a much more affordable cost structure and plus, you’ll have access to many advisors in each of the different fields of expertise to make sure you have the right fit for you and your business.

In the future articles we will discuss strategies to eliminate the self-employment taxes and reduce your individual income taxes with special tax planning techniques.  These special tax planning techniques will eliminate any need to pay estimates taxes.

Then in Chapter 14 we will go in-depth with the different business structures.  The IRS code has a variety of different types of business structures.  Each business structure will have its only set of IRS codes and rules. 

Some of the business structures allow small business operates to eliminate self-employment taxes.  Let me state that again –some business structures have built in rule to eliminate the self-employment taxes completely! 

The new Tax Cuts and Jobs Act will add additional benefits and tax reduction strategies for business owners.

Future chapters will continue to discuss the opportunities to reduce income taxes as well.  As you will learn there are two different taxes that self-employed workers have to pay.  Self-employment taxes and income taxes.  One of the best strategies is to set up a business structure that will eliminate the self-employment taxes.

Call now for your free consultation to learn how we can help grow your business!

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