Many people are turning to self-employment as a way to make a living. However, self-employment isn’t as easy as some may think! Factors like paperwork, tax implications, and more, can make self-employment very stressful to deal with. It’s much more than just some self-employment income. That’s why it’s important to understand the tax side of things so that if you choose self-employment as a way to make money, you aren’t caught off guard.
Understanding What Self-Employment Is
In order to fully understand self-employment tax, you must first understand self-employment. If an individual is self-employed, they do not work for an employer. This means they also don’t make a consistent salary or wage from an employer. Instead, people who are self-employed, also known as independent contractors, earn money from conducting business with a payer. Most of the time, the payer will not withhold taxes for a self-employed individual. This leaves the entire responsibility to the individual doing the work.
Who is Considered Self-Employed?
If you want to find out if you’re considered self-employed, there are a few different things to keep in mind. Even side gigs can be considered a form of self-employment! An individual can be considered self-employed if they:
- Are the sole proprietor of an unincorporated business
- Are an independent contractor
- Work as a consultant or freelance
- Are apart of a limited liability company (LLC)
- Earn income through investments (even rental property)
- Work with the intent to make a profit (even if they don’t earn any)
- Have regular transactions from their business or trade
- Produce income from their business or trade
- Make decisions for the sake of the continuing their business or trade
You can get a better understanding of who is considered self-employed by reviewing the Internal Revenue Service’s (IRS) Website. The IRS has a simple definition of who is considered self-employed. According to the IRS, typically individuals are self-employed if any of the following conditions apply:
- An individual carries on a trade or business as an independent contractor or sole proprietor
- A person is a part of a partnership that carries on a trade or business
- An individual is in business for themselves (this includes part-time business)
Self-Employment Tax Obligations
Self-employment tax is different from the taxes of a typical employee. That is because a typical W-2 employee will be responsible for a tax rate of 7.65%. The other half would be covered by the employer. However, for individuals that are self-employed, they are responsible for the entire 15.3%.
Different Types of Self-Employment Tax Forms
The person who pays a self-employed individual must provide a tax form. Recipients of this self-employment income can expect to receive either a 1099-NEC, 1099-MISC, or a 1099-K. However, if an individual doesn’t receive any of these forms, they are still responsible for reporting their income and expenses from self-employment on their tax return.
How to Declare Self-Employment Income and Taxes?
In order to properly declare your self-employment taxes, you must first figure out your self-employment income. You need to figure out your self-employment income, and compare it to your business expenses so that you can find your net-earnings. Your net-earnings is what self-employment tax is based on. For example, if your business expenses were $50,000 but you made $100,000 then you have a net-earnings total of $50,000.
The self-employment tax rate is 15.3% but can be broken down into two different numbers. 12.4% is for Social Security tax and 2.9% is for Medicare tax. It is important to keep in mind that only up to $142,800 of your net earnings can be eligible for the Social Security tax. That means depending on how much you make, you may see a different tax amount due compared to another self-employed individual.
Now that you know your net earnings, you want to get IRS form SE, Self-Employment Tax from the IRS website. Here you will provide details like your self-employment profit. You will then want to multiply the amount on Form SE by .9235 (since only 92.35% of your net earnings can be taxed). So if your net-earnings were $50,000, that number multiplied by .9235 would be $46,175. That is the amount that is subject to self-employment tax. Then multiply that number by .153 (the self-employment tax rate). However like we mentioned above the Social Security portion of that tax rate is only applicable on up to $142,800 of your net earnings. This math can be hard which is why we recommend that you get the help from a professional to ensure that you are submitting the right information to the IRS.
Commonly Asked Questions About How to Pay Self-Employment Tax
Understanding self-employment tax can be difficult. Even if we break it down into simple terms, there are still rules that apply that can make figuring out the actual amount you owe difficult. Again, we recommend that you get the help from a professional so that you can ensure you are handling your taxes properly. Many people who learn about self-employment tax tend to have questions, so if you have some, you are not alone!
How to Make Quarterly Payments?
Another component of self-employment taxes is the fact that individuals need to make payments throughout the year, not just by the annual filing deadline. If a person waits for one payment at the end of the year, they are subject to late payment penalties. In order to properly calculate your quarterly estimated tax payments, you have to estimate your adjusted gross income, taxable income, taxes, deductions, and credits for the entire year. This can be extremely difficult to do on your own! The IRS provides a few different methods when it comes to submitting these payments. An individual can:
- Credit an overpayment on your previous year tax returns towards your next year’s taxes
- Mail your payment and payment voucher with a Form 1040-ES
- Pay over the phone
- Pay online
- Have the funds electronically withdrawn
How to File an Annual Return?
If you want to file your annual tax return, you will need to use Schedule C to report your income and losses (if any) of your self-employment. In order to report your self-employment tax, you need to file Schedule SE (Form 1040 or 1040-SR). The information on Schedule C will be able to help you fill these out. We will sound like a broken record but we don’t care! We recommend that you file an annual return with a professional accountant who can walk you through every step. However, if you want to file an annual return yourself, you will need to get the appropriate tax forms. For more information, visit the IRS website where they can go over what you need to do.
Where to Declare Self-Employment Income?
If you have any questions about the documentation for the IRS you should speak to a professional.
What are Some Deductible Business Expenses?
You can think of deductions as anything for your business. For example, if you buy a fax machine to be able to handle faxes for your self-employment, then you can consider the fax machine deductible! You should speak to a professional about what available tax-deductions you can consider.
When you choose the path of self-employment, you also choose to handle the tax side of things (not just reap the benefits of self-employment income). Understanding the taxes of self-employment can be difficult. In order to fully understand the tax aspect, you must first look at what self-employment means.
Individuals that deal with self-employment tax must look at their net-earnings, not just their income. 92.35% of their net-earnings are subject to the self-employment tax rate of 15.3%. It is also important to keep in mind that the self-employment tax rate is the sum of two numbers. Both a Social Security tax rate, and a Medicare tax rate. The Social Security tax rate is only applicable on up to $142,800 of your net earnings. Due to all of these factors, we recommend that you get help from a professional to make sure you are submitting accurate information into the IRS.