How to calculate and file taxes when self-employed

How to calculate and file taxes when self-employed

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Being self-employed allows you the opportunity to work on your own terms. This freedom and control is enticing for many individuals, though one potential drawback is the need to manage your own taxes—and the questions that raises. What is self-employment? How do you know how much you pay? Do you rely on accounting professionals to assist you?

This article will help you understand these questions and more, so you can remain in compliance with the IRS and hopefully even save some money in the process.

Who pays self-employment tax?

The following situations require you to pay taxes on your self-employed income:

  • You earned at least $400 in net self-employment income during the tax year
  • You earned over $108.28 as an employee of a church

To be clear, this means that you’ll pay self-employment tax even if you have a regular job. If the income from your side hustle reaches $400, you’ll have to report this net income on your tax return.

The only time when you won’t have to pay self-self employment tax is when your employer already takes out your payroll taxes or when your net earnings fall below the $400 threshold.

How much is self-employment tax?

The self-employment tax rate is 15.3%. This rate includes:

  • 12.4% for the Social Security portion
  • 2.9% for Medicare

However, it’s a bit more complicated than that. The Social Security percentage only applies to a portion of your self-employment income. This limit is known as the Social Security wage base.

The Social Security wage base in 2022 is $147,000. This base means that if you earn $160,000 in business income, you’ll only pay 12.4% on the first $147,000. No Social Security tax will be applied to the remaining $13,000.

There is no such limit for your Medicare taxes. In fact, high-wage earners will have to pay an additional Medicare tax of 0.9%. This extra tax kicks in when your income exceeds the following thresholds:

  • Married couples filing jointly: $250,000
  • Married filing separately: $125,000
  • All other filing statuses: $200,000

Since there’s no limit to this additional Medicare tax, you’ll continue to pay this self-employment tax regardless of your income.

What taxes do I pay when self-employed?

Broken down, the taxes self-employed people must pay include:

  • Income tax: Required of all Americans and businesses, paid as-you-go.
  • Self-employment tax: Social Security and Medicare requires 15.3% of your income.
  • Sales tax: Almost all states require a tax on sales, and you may also be subject to city and county taxes. Sellers collect sales tax and pay the necessary states, cities, or counties regularly.

When you are self-employed, you are responsible for both the employer and employee side of taxes. Since self-employed individuals are essentially operating as their own employer, they are responsible for this set of taxes.

After the federal government passed the Self-Employed Contributions Act (SECA) in 1954, self-employed individuals became responsible for paying both their portion of these taxes as well as the employer portion.

In other words, self-employed people must pay the full 15.3% to cover their Social Security and Medicare obligations. This tax is commonly called the “SECA tax,” “self-employment tax,” or sometimes simply “SE tax.”

In addition, when you work for another business, your Social Security and Medicare taxes are split between you and your employer. This arrangement means that you’ll pay 7.65%, and your employer will pay the other 7.65%.

*Note: Small businesses, freelancers, sole proprietors, and anyone expecting to owe more than $1,000 in federal taxes in the current year should calculate and pay estimated quarterly taxes.

Self-employment tax vs. income tax

It’s important to remember that self-employment tax and income tax are completely different. Income tax is simply a tax applied to the money you earn from your job. Everyone must pay income taxes regardless of who they work for.

Self-employment tax is meant to pay for the costs usually covered by payroll taxes. This setup means that self-employed individuals must pay tax on their income in addition to paying their self-employment tax.

How to calculate and pay self-employment taxes

You’ll have to pay self-employment taxes annually, and these taxes are due at the same time that you pay your income taxes.

This guide will walk you through your self-employment tax calculation, showing you how to determine how much money you owe and how to walk through the process of paying taxes as a self-employed person.

1. Calculate your net self-employment income

First, you’ll need to calculate your net earnings from self-employment. Your net earnings can be determined by subtracting your business expenses from your gross income.

You’ll typically calculate your net self-employment earnings using a Schedule C as part of IRS Form 1040, your federal income tax return. If you’re a sole proprietor, small business owner, or independent contractor, you must fill out Schedule C as part of your tax return.

2.  Determine tax bracket

The Tax Rate Schedule is first determined by your filing status (Single, Married filing jointly, Married filing separately, and Head of Household) and your income. Your federal income tax bracket will determine how much you should be paying as a general foundation.

For example, someone making $95,000 annually and filing jointly as a married couple has a 22% tax rate. They’ll owe $9,235 plus 12% of the amount over $80,250 (which comes out to 1,770), totaling $12,775 in taxes. But that’s without any deductions or credits, so you can reduce your taxable income.

3. Determine whether you are above the Social Security wage base

If your net earnings from self-employment fall below $147,000 (for 2022), the rest of your calculation is quite simple, and you can simply proceed to step 4 below.

But if you’ve had a particularly good year, your self-employment taxes are slightly more complex. Refer to our section below with instructions for high earners under step 4, and we’ll explain how to calculate the tax on this income.

4. Calculate your self-employment tax

For tax year 2021, self-employment tax is 15.3% up to $142,800 and 2.9% on any net income above that threshold.

If your net earnings fall below the Social Security wage base of $142,800, you can calculate your self-employment tax quite easily.

Start by calculating your taxable income. Since your employer already paid their portion of the FICA taxes (7.65%), you’ll simply multiply your net income by the remaining 92.35%.

For example, if you earned $60,000 in net income for the year, you’ll multiply this number by 0.9235. This math means that you’ll have to pay self-employment tax on $55,410.

Next, you’ll calculate your self-employment taxes. You’ll simply multiply your taxable income by the self-employment tax rate of 15.3%. Continuing our above example, you’ll multiply $55,410 by 0.153. This result means that your total self-employment tax comes out to $8,478.

Once you have this number figured out, you can skip ahead to step 5, which will walk you through the filing process.

High wage earners will calculate their self-employment tax differently

If your net earnings from self-employment exceed $147,000, you’ll have to do just a few more steps. For example, if your net earnings came out to $150,000, you’ll only pay tax on the first $147,000. But this also means that you’ll use a separate calculation for Social Security and Medicare taxes. Just follow these additional steps:

  • Calculating Social Security tax: According to the IRS, your first $147,000 will always be considered taxable if you meet this wage base. If we use the above example, it means you’ll pay the 12.4% Social Security tax on $147,000, but your remaining income ($3,000) will not be touched by Social Security tax.
  • Calculating Medicare tax: To determine your Medicare tax, start by calculating your taxable income. Simply multiply your net earnings by 92.35%. In our example, this comes out to $138,525. To calculate your total Medicare tax, multiply this number by the tax rate of 2.9% ($138,525 x 0.029). Your final Medicare tax will come to $4,017.
  • Calculate your total self-employment tax: Once you make your calculations for your Social Security and Medicare taxes, you can simply add these numbers together to determine your grand total.

5. File your self-employment tax annually

If you’re subject to self-employment taxes, you’ll need to file Schedule SE along with Form 1040. Generally, your taxes will be due on April 15 of each year, though, in 2022, this deadline has been pushed to April 18 to accommodate the Easter holiday.

6. Make estimated tax payments during the year

If your net earnings from self-employment exceed $1,000, you’ll need to submit quarterly estimated tax payments throughout the year. IRS Form 1040-ES can be used to make this calculation, which basically takes the amount you’ll owe for the year, and splits it into four equal payments.

These estimated taxes are due on the following dates:

  • April 15
  • June 15
  • September 15
  • January 15 (of the following tax year)

If the 15th should fall on a weekend, the deadline gets moved to the first Monday after the original deadline.

Form 1040-ES includes vouchers that you can use when mailing in your tax payment, though you may find it easier to use the IRS Direct Pay website. Keep in mind that the IRS website isn’t as intuitive as you might prefer, so make sure to keep records of your payments.

Planning for self-employment taxes

Once you have a total for your estimated taxes, you need a strategy for setting the money aside so you’re not surprised each quarter, or worse—at tax time.

The strategy that works best for you will depend on the stability of your freelance income and any expenses that offset that income. Play around with the numbers to determine which makes more sense for your situation.

Here are two tried-and-true strategies for managing your quarterly estimated tax payments.

Monthly: Divide your annual estimate by 12 and transfer that amount into a separate tax or savings account each month.

Percentage: Figure out the percentage of your income that will be required, then transfer that percentage of each payment to your tax or savings account. For example, if you will be paying 20% of your income in taxes, you’ll take 20% of each paycheck and transfer it directly to your tax or savings account.

In addition, here are some tips for how to plan well and reduce your next tax bill:

Deduct your self-employment taxes

The easiest way to reduce your tax liability is through a tax deduction. Self-employed taxpayers have access to the self-employment tax deduction. The IRS allows you to deduct half of your self-employment tax from your net earnings as an income tax deduction.

Deduct other business expenses

Business owners can take advantage of other tax deductions as well. To qualify as a tax-deductible expense, these items must be used for the express purpose of generating income.

Common tax-deductible expenses include:

  • A home office
  • Utilities and internet
  • Health insurance premiums
  • Meals
  • Travel
  • Business insurance

Just remember that you’ll need to keep a careful record of these business expenses in order to use them as tax deductions on your upcoming return.

If you’re unsure whether an expense is tax-deductible, run it by a tax professional.

Take advantage of tax credits

You may be able to take advantage of certain tax credits, such as the Earned Income Tax Credit (EITC). If your adjusted gross income (AGI) falls below a certain threshold, you’re entitled to a tax credit as high as $6,935.

The exact amount of the credit depends on the number of children you have as well as your filing status. If you’re married filing jointly, you’ll receive a larger credit than if you are filing as single or the head of your household.

Maintain careful records

If you’re self-employed, it’s important to maintain careful records of your income and expenses all year long. This approach will help you calculate your net earnings and determine your tax liability in advance.

Additionally, you’ll be better equipped to take tax deductions, having saved receipts and documents to back up these expenses.

This ease is why using a digital platform for business banking is so helpful, as it will maintain these records for you. You’ll always have quick access to your financial information so that you can stay on top of your self-employment earnings.

Keep up with your quarterly payments

Schedule SE is due on April 15 of most tax years, but if you wait until the deadline, you may find yourself in hot water with the IRS. If you don’t report and pay your taxes accurately, you may face fines, penalties, and other legal fees.

Keeping up with your quarterly estimated tax payments ensures that you’re planning appropriately and that you’re not caught by surprise by your yearly tax bill.

How to file taxes

Quarterly estimated tax payments can be mailed using the printable vouchers in Form 1040-ES or use IRS Direct Pay to pay online. State and local taxes may not require quarterly filing, and may have their own procedures for payments, so work with a tax professional to be sure you’re paying taxes correctly.

Frequently asked questions

For specific tax advice, please consult a professional. But for a general overview, we have assembled answers to some common questions regarding self-employment taxes:

Are any jobs exempt from self-employment taxes?

Self-employment tax applies to those who earn over $400 per year. The only self-employed individuals who don’t have to pay taxes are those whose income falls below this threshold. The type of job makes no difference to the IRS; it all comes down to your income threshold.

When do I pay taxes?

Taxes were due Monday, April 18, 2022 for individual filings (which includes self-employed individuals). Quarterly taxes for businesses are due April 15th, June 15th, September 15th, and January 15th.

How do you show proof of income if you are self-employed?

You can show proof of income as a self-employed individual by showing annual tax returns, bank statements, or profit-and-loss statements.

How much money should a self-employed person put back for taxes?

The amount you should set aside for taxes as a self-employed individual will be 15.3% plus the amount designated by your tax bracket.

Do self-employed individuals pay more in taxes?

The short answer is yes, self-employed individuals usually pay more in taxes. However, they are also able to deduct half of the self-employment tax, as well as business deductions like home office and operations expenses.

Is self-employment tax the same as a 1099?

If you received Form 1099 from your employer, then this means you’re classified as an independent contractor or freelance employee. You’ll need to pay self-employment tax on this income using the method described in this article and submit Form 1040 SE.

Do I pay self-employment tax on rental income?

Rental income is classified as a form of passive income, which also extends to things like stock dividends and interest you’ve earned.

The IRS requires you to pay income tax on this money, but you won’t have to pay self-employment tax on rental income or any other form of passive income.

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