Self-employment tax is used to describe the federal income tax and social security and Medicare taxes that are paid by self-employed individuals.
This is fairly more difficult than being a W2 employee, as you don’t have an employer withholding money from your paycheck each month for federal income taxes, social security, and Medicare
Therefore, you must pay these taxes or owe them when you file your tax return for the year. The good news is that many of the same deductions that are available to W-2 employees are also available to self-employed individuals.
In this article, we’ll go over all the things you need to know about self-employment taxes, from who is required to pay it to how you file your income taxes as a self-employed person.
Who pays Self Employment Tax?
Self-employment sector of our labor force, such as freelance artists, independent contractors, and small business owners is booming. This uptrend began way before the COVID-19 crisis even started.
However, the numbers grew significantly last year. According to Forbes, nearly 1.6 million applications for new employment identification numbers were received by the IRS in 2021.
You are considered as “self-employed” if you are an independent contractor or run a sole proprietorship (a one-owner business that is not incorporated), including a single-member limited liability company that is taxed as a disregarded entity for income tax purposes, or if you are an active partner in a partnership.
You have net earnings from self-employment if your gross income from self-employment is more than the total of your deductions for the cost of goods sold, plus any home office deduction and other expenses deducted under the rules for Schedule C filers.
Are there any exceptions to Self Employment Tax?
There are a few exceptions to self-employment tax you should know about. If you perform services as a minister, member of a religious order, or Christian Science practitioner, you do not pay freelancer tax on wages received for those services.
The same rule applies to qualified performing artists and certain professional athletes.
In order to be responsible for paying self-employment tax, you must have net earnings from self-employment of at least $400.
Net earnings from self-employment are gross income from your business minus ordinary and necessary expenses that are associated with running your business.
What is a 1099 Form?
If you’re self-employed, you may be issued a 1099 form by individuals or businesses with which you have made transactions
These forms are used to report income that isn’t from wages. They include items like rental income, interest, dividends, and commissions.
You don’t need to wait until January to file your return (for the previous tax year) if you receive 1099 because these forms now come with an assigned IRS transmittal number. However, you must still attach the 1099s to your federal individual income tax return.
What is Schedule C?
If you are a sole proprietor or an independent contractor, Schedule C is used to report your business income and expenses.
This includes everything from the income you make from the products or services you provide to your business, any other personal service income you may have, your share of any partnership or S corporation income (if applicable), and deductions for expenses associated with your business.
It’s easy to lose track of these, so you need to make sure that you create efficient bookkeeping and invoicing process.
What are some common business expenses that are deducted on Schedule C?
There are three main categories of deductions on Schedule C. These include ordinary expenses, necessary expenses, and startup costs. Some examples of items that fit into these categories are listed below:
- Advertising costs
- Cell phones
- Auto loan interest expense
- Legal and professional services
- Office supplies
- Meals and entertainment (subject to limitations)
- Insurance premiums
- Website design, development, and hosting services (up to $2500)
Remember that to be deducted, your company costs must be ordinary and necessary to run your firm—they cannot be personal.
How can someone calculate their net earnings from self-employment?
If you are self-employed, then your net earnings from self-employment will be the total amount of money that you made. That amount can also include things like bonuses and commissions.
This figure is important because it’s the starting point for figuring out how much in taxes you owe on this income throughout the year
So, assume you make $1,500 from a freelancing job and subtract $500 from your income. To calculate your taxable income, multiply the net income of $1,000 by 92.35%. Only $923.50 is liable to self-employment tax in this case.
After you’ve got a good sense of your taxes, make sure you maintain track of your company spending. It’s easy to get caught up in the excitement of new clients and projects, but it is important not to overspend.
Whether you are a business owner, freelancer, or independent contractor, you are responsible for paying self-employment tax on your net earnings from self-employment. However, it’s a little more difficult to file taxes as a self-employed person than it is to file a W-2 employee form.
You’ll have to handle a lot of the tax arithmetic yourself. You may benefit from expert tax assistance if you are overwhelmed or puzzled by the paperwork and requirements.