Navigating the World of Self-Employment Taxes

The freedom to follow your passion and establish your own hours are only two advantages of being self-employed. However, it also has additional tax obligations that you might not be aware of. In this article, we’ll examine some of the major tax issues that affect self-employed people and discuss how to deal with them.

What Does “Self-Employed” Mean?

Self-employment means that you run your own business or provide freelance services as a sole proprietor or independent contractor, rather than working for someone else. Individuals who work for themselves must pay both the employer and employee portions of Social Security and Medicare taxes, also known as self-employment taxes.

Examples of activities that would make someone self-employed include:

  • Owning and operating a small business
  • Providing freelance services, such as writing, photography, or consulting
  • Renting out a room in their home on platforms like Airbnb
  • Driving for ride-share services like Uber or Lyft
  • Delivering food or other goods for companies like DoorDash or Amazon Flex.

What Are Self-Employment Taxes?

Self-employment taxes are taxes paid by self-employed people to cover their Social Security and Medicare contributions. These taxes are calculated based on the net income earned from self-employment, with a maximum earning limit that is subject to change annually.

The self-employment tax rate is currently set at 15.3%, with 12.4% going to Social Security and 2.9% going to Medicare. It is important to note that self-employed individuals are responsible for both the employer and employee portions of these taxes, as opposed to employees, who have their employer pay half of their Social Security and Medicare taxes.

Self-employment taxes must be paid quarterly in the form of estimated tax payments, or an individual may elect to have these taxes deducted from their business earnings. The Internal Revenue Service may levy penalties and interest if self-employment taxes are not paid.

Calculating Self-Employment Tax

Self-Employment tax applies to anyone that receives $400 or more from self-employment or $108.28 or more if you are a church employee. The tax is divided into two parts – Social Security and Medicare tax. Each is calculated differently.

Social Security Tax

As of 2022, self-employed individuals owe 12.4% for social security on the first $147,000 of net earnings. If you make more than $147,000 in a year, the rest of the earnings are not taxes for social security.

Medicare Tax

As of 2022, self-employed individuals pay 2.9% on their first $200,000 of net earnings for Medicare.

If married, you will pay 2.9% on the first $250,000 of combined self-employment earnings filing jointly or $125,000 filing separately.

For earnings over the income threshold, you must pay an additional 0.9% in Medicare taxes which increases the tax rate to 3.8% for the higher income earners. Unlike the Social Security portion, there’s no maximum amount for the Medicare portion of self-employment tax.

How to Pay Self-Employment Taxes

It’s also important to be aware of estimated taxes, which self-employed individuals are required to pay throughout the year. These taxes are based on your expected income and self-employment taxes for the year and are generally due on a quarterly basis. Failure to pay estimated taxes can result in penalties and interest, so it’s important to stay on top of these payments.

If you expect to owe more than $1,000 in self-employment taxes, you are responsible for making estimated quarterly tax payments to the IRS by mail or online via website or app. And when you file your taxes, you will file an annual tax return using Schedule SE to report your self-employment taxes paid.

To prepare for the 2023 tax year, here are the due dates for the quarterly tax payments:

  • If you earn income from January 1 – March 31, 2023, then your payment is due on April 18, 2023
  • If you earn income from April 1 – May 31, 2023, then your payment is due on June 15, 2023
  • If you earn income from June 1 – August 31, 2023, then your payment is due on September 15, 2023
  • If you earn income from September 1st to December 31st, then your payment is due on January 15, 2024

Here at Giles Consulting, in most situation we advise clients to set aside at least 30% of their net self-employment income throughout the year in order to be able to pay their Social Security, Medicare and income taxes.

Tax Deductions for Self-Employed Individuals

Not only do you have to pay ordinary income taxes, but you also have to pay self-employment tax which encompasses the part your employer would typically pay directly. This means a lot more of the tax burden is coming out of your finances. Which makes one of the most significant tax benefits for self-employed individuals is the ability to deduct business expenses.

As a self-employed individual, your tax liability is based on your net earnings. Net earnings refer to your gross business income minus the deductions the IRS allows you to claim. When it comes to filing your taxes, you may be able to deduct a variety of expenses, including your computer, travel, gas costs, and even retirement savings. Here are few strategies and common tax deductions for self-employed.

  • Maximize your contributions on retirement plans to lower your taxable income.
  • Take deductions for business overhead expenses, including any equipment or property you use in the course of your business.
  • Make donations to charity organizations, as you won’t have to pay income tax on the money you contribute.
  • Maximize your Health Savings Account contributions to take full advantage of deductions.

Self-Employment Tax Deduction: You may reduce your net earnings by half the amount you paid in social security taxes. Half of your social security tax (the part employers typically pay for employees) may also be deducted.

Home-office deduction: Another good way to save money on your taxes is to use the home office deduction. However, be cautious when claiming this deduction because the IRS has strict limitations on it. Rent, insurance, utilities, repairs, and mortgage interest are all allowable deductions. Direct expenses are completely tax deductible. Indirect expenses may be deducted in one of two ways. You can use the simplified method or the regular method which is based on the percentage of your house or apartment that your office occupies.

Qualified Business Income Deduction: If you have a “pass-through” business entity like a sole-proprietorship, partnership, S corporation, or LLC, you may be able to deduct up to 20% of your qualified business income (QBI) on your taxes. QBI is your company’s profit, minus non-qualified income.

Other Business Tax Deductions

  • Advertising and marketing costs
  • Bank fees
  • Business travel
  • Mobile phone and Internet costs
  • Continued Education
  • Health insurance premiums
  • Legal and professional fees
  • Start-up costs
  • Tax Advice and preparation fees

Personal Tax Deductions

  • Charitable donations
  • Medical expenses
  • Mortgage interest
  • Moving expenses
  • Retirement contributions
  • Student loan interest

These are just a few of the more common tax breaks available to self-employed individuals. A tax professional may be able to identify additional deductions. They may also assist you in determining which deductions apply to your specific situation.

Be sure to keep accurate records of all your business expenses, because you will need to provide documentation when claiming your deductions. Because tax laws and regulations change, it’s crucial to stay educated and consult a tax professional to make sure you are fulfilling your tax duties.

Don’t let taxes stress you out – take action now and get the help you need to ensure your taxes are filed correctly and on time.

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