The number of people that employ themselves is rising. This includes freelancers, gig workers, small business owners, and startup finders. It is not surprising that this sector is rising as the advantage of self-employment makes it appealing to many.
As appealing as self-employment is, people in such categories still have to pay taxes. The good news is that this tax is a little price to pay, and you can minimize the entire amount you pay with the right strategy.
Here is essential information about self-employment taxes you need to know.
Know what Self employment tax means
Medicare and social security taxes are all part of self-employment taxes. Self-employed people do not get paychecks in which taxes will be deducted automatically. The self-employment tax stands in place of traditional social security and Medicare.
FICA (Federal Insurance Contribution Act) was established in 1935 to provide funds for Medicare and Social Security. FICA tax is 15.3% at the moment. This is shared between employers and employees.
As self-employment progressed, the federal government wanted to ensure such people send their share to Medicare and Social security. This gave birth to the Self-Employed Contributions Act (SECA) in 1954, requiring that self-employed people pay all the 15.3% to SECA.
Learn How to Calculate Self-employment Tax
There is Schedule SE that comes with Form 1040 for tax filing. This is a worksheet that can help calculate self-employment tax.
The tax rate is 15.3%, including 2.9% for Medicare and 12.4% for Social Security. This amount is applied to the net earning, meaning that you have to subtract any deductions such as business expenses from gross earnings.
Every year, the IRS could change the portion of the total wage, net earnings and tips are subjected to self-employment tax. In 2019, Social Security took part in the first $132,900 of the self-employment tax rate. For 2020, this has increased in 2020 to $137,700. The entire wages, tips, and net earnings fall under the 2.9% of the Medicare part of self-employment tax.
Decide if you need to pay self-employment tax.
Sole proprietors, people in trade or business, or independent contractors need to pay self-employment tax. In addition to income tax by the small business owner, they must also pay the tax.
Calculate the net profit or loss you made from your business. For a net earning over $400, you must file an income tax and calculate your self-employment tax. This is how to pay a self-employment tax.
Self-employment taxes are directed at people who work but do not have their taxes removed automatically from their employer's paycheck. This applies to everyone, irrespective of income bracket and age.
Self Employment tax is a Deductible Expense.
You can deduct some part of your self-employment tax to take care of your income tax. This, however, does not affect your self-employment net earnings or taxes.
If you file Schedule C with Form 1040, you might qualify for the Earned Income Tax Credit (EITC).
The self-employment health insurance tax deduction is also another financial relief for small business owners. If you pay it directly, a part of your health insurance cost could be deducted for your self-employed healthcare plan.
You, however, cannot claim this deduction if you pay it via an insurance marketplace. This is because you already have a credit coming in via the insurance.
Know how to Pay Self-Employment Tax
You will have a record of all your self-employment tax on your tax filing. It will be part of the parameters used to determine if you owe money or qualify for a refund.
To fulfill your tax obligation, you need a Social Security Number or a Tax Identification Number to pay your self-employment tax.
You must also make quarterly estimated tax payments. This includes payment for estimated income tax as well as payments for self-employment tax.
Conclusion
Make sure you contact a tax pro for help and advice on self-employment tax on a final note. As self-employed individuals, the tax filing process could be complicated. Not getting it right might make you miss out on benefits or deductions. Also, wrong filing can be enough grounds for fines.
