What do business owners and freelancers need to know about self-employment tax?
Nothing can be more exciting than working for yourself and being your own boss. When you are in business for yourself, you can work when and where you please, and choose whom you would like to work with. However, while you can have greater freedom from being self-employed, it also comes with greater responsibility. For one, you have to pay your own taxes.
The Self-Employment Tax: Understanding the Basics
According to Investopedia.com, the self-employment tax (also known as the Self-Employment Contributions Act) refers to the amount a business owner must pay for his Social Security and Medicare payroll taxes. If you have just been self-employed, do not be surprised if you notice a sudden increase in your tax bills at the end of the year.
Self-employed people usually pay higher taxes than regular employees. Since they are both the company and the employee, they are solely responsible for paying for their Social Security and Medicare. On the other hand, employees share this cost with their respective employers so they end up paying less.
Who are required to pay the self-employment (SE) tax?
You are required to pay the SE tax if your net earnings from self-employment were $400 or more, and/or if you had church employee income of $108.28 or more. The self-employment tax rules apply regardless of age. The same rules apply even if you are already receiving Social Security or Medicare.
How much do you have to pay?
Self-employed individuals are required to pay 15.3% of their eligible wages to the IRS. This will be divided into two parts – 12.4% for Social Security and 2.9% for Medicare. For 2015, the Social Security tax applies to the first $118,500 of net self-employment income. Anything above this amount would not be subjected to tax.
However, for the Medicare portion, you are required to pay the 2.9% tax no matter how much you earn. Starting 2013, higher-income earners are also required to pay an additional 0.9% Additional Medicare tax.
How should you report your SE tax?
When you start a small business and do not incorporate or form a legal partnership, you should report your net profit or income on a Schedule C and file it with your Form 1040. You calculate your self-employment tax on Schedule SE and report the amount in the Other Taxes section of Form 1040. This will help the IRS differentiate the SE tax from the income tax.