As a self-employed individual, learning the self employment tax rates, business deductions, and quarterly estimated payments, among others, is a must. After all, working by yourself or managing a business does not exempt you from paying your dues to the government. In fact, you bear complete responsibility for all of them.
Self Employment Tax Rates | A Guide to Remember
In This Article:
What Is Self-Employment Income?
To understand self employment tax rates, you first need to understand self-employment income. If you are a sole proprietor, independent contractor, or freelancer, you are self-employed.
It means you receive income from clients or from companies that issue you a 1099-MISC. Those funds are your business’s revenue. They are not your self-employment income yet.
When you are self-employed, the IRS considers you to be a small business owner, and you can write off your business expenses as a tax deduction. Then, the difference is your self-employment income.
To explain, imagine you run a successful store on Etsy. You earn $20,000 in sales for the year, but you spend $1,000 on supplies, shipping, and other business expenses. To find your self-employment income, you take your sales ($20,000) minus your business expenses ($1,000), so your actual income is $19,000.
Remember: When you file your tax return, you cannot just note $19,000 of self-employment income. The IRS requires you to fill out Schedule SE with your 1040 Individual Income Tax Return (you can learn more about business tax forms here).
What Are the Self Employment Tax Rates?
When you are self-employed, you have to pay Medicare premiums and make Social Security contributions on your self-employment income.
As of 2018, the self-employment tax rate for Social Security contributions is 12.4%, and it applies to all income up to $128,700. The rate for Medicare hospital insurance is 2.90%, and it does not have an income threshold. When you add both of those items, your self-employment tax rate becomes 15.30%.
To continue with the above example, if you have $19,000 in self-employment income, your self-employment tax is $19,300 x 15.30% = $2.952.90. This includes only the self-employment tax, not the income tax.
Self Employment Tax Rates Versus Employment Tax
When you are an employee, you still have to pay Social Security and Medicare taxes, but it is usually not as much as when you are self-employed.
Get this: when you have an employer, you pay half the Social Security tax (6.2%), and your employer pays the other half (6.2%). Self-employment means paying both tax rates. The same principle applies to Medicare taxes.
With income tax, however, the amount can be the same.
Self Employment Income Tax Rates
Self employment tax rates are different from those of income tax. To get taxable income, start with your self-employment income. Let us say you earned $100,000 from your business, and you had $20,000 in business expenses. Your self-employment income is $80,000.
Then, the IRS lets you subtract a standard or an itemized deduction from that amount. An itemized deduction is the combination of a number of small deductions such as mortgage interest, medical bills (over a certain threshold of your income), charitable contributions, and several other personal deductions.
You must only use the itemized deduction if it is higher than your standard deduction, and that applies to less than a quarter of all taxpayers.
As of 2018, the standard deduction has been about doubled, and if you are a single person, it is $12,000. You subtract this amount from your self-employment income, and you get $68,000.
You can continue claiming more deductions to lower your taxes and save more money. These can include student loan interest, certain retirement account contributions, and a few other items.
Then, let us say these deductions bring your income down from $68,000 to $66,000. This is your taxable income, and the IRS assesses your income tax on that amount.
Besides deductions, you may also qualify for credits. These amounts help to lower the tax you owe, and sometimes they can even trigger a refund, but when you are self-employed, refunds are rare.
To be on the safe side, always consult with an accountant or use quality tax prep software, which does not require you to know a lot about taxes. It just asks you questions to help you figure out your deductions and credits.
Pass-Through Income Deduction
The 2018 tax plan introduces a new tax deduction that applies to pass-through income, which are earnings that pass through your business directly to you. If you are self-employed, your income is most likely it.
The specifics of the pass-through income deduction are a bit tricky, but here is the gist of it. Basically, you can claim a deduction worth 20% of your pass-through income. However, the deduction cannot exceed 20% of your taxable income.
Additionally, if your income is above a certain level, you cannot claim this deduction if you run a service-based business (lawyer, broker, consultant, etc.). Whether you are in a service-based industry or not, if your income is over a certain threshold, you have to calculate the deduction based on your company’s total assets and the amount you pay to employees.
When you are self-employed, you may have to pay estimated self employment tax rates every quarter. Basically, your first year is free.
Then, if you owe over $1,000 that year, you need to pay quarterly the next year or the IRS assesses a late fee. You can make your quarterly payments based on what you owed the previous year. For instance, if you owed $4,000 in 2017, you can pay $1,000 per quarter in 2018.
If you owe more, you can settle when you file your tax return the next year. If you think you have less due, you can do a few calculations and base your estimated tax payment on your actual earnings.
Can the new tax law change your self employment tax rates? Find out more from Action from Square One:
When you are self-employed, you have a lot more tax responsibilities than the average person. You have to pay your own FICA taxes, track your business expenses, know the self employment tax rates, and potentially pay estimated tax quarterly. A lot of people end up with a tax bill, especially in the first few years, as they get used to running their own business. If you have a tax debt, you can get back into good standing with the IRS. To get help, contact us at Tax Relief today.
Do you have more questions about self employment tax rates? Let us know in the comments section below.