Working for yourself offers a number of attractive benefits. After all, as your own boss, you get to call the shots and work how you’d like—when you’d like. Of course, the other side of that equation is managing the responsibilities that go along with running the show.
Chief among these responsibilities is filing taxes when you’re self-employed.
There are a few differences between filing your taxes as a self-employed person and an employee of a company.
One of the most significant of them is the self-employment tax.
The Self-Employment Tax
Comprised of Medicare and Social Security taxes, the self-employment tax rate can vary from year to year. For 2023 it’s 15.3%, of which 12.4% goes toward shoring up your Social Security fund and 2.9% supports your Medicare account.
If those numbers strike you as being high, keep in mind that regular employees have the benefit of their employers shouldering a bit of that burden on their behalf. As a 1099 contractor or a self-employed individual, you are both the boss and the employee. So, you’ll cover both parts of those payments.
Social Security tax is only applied to the first $160,200 of the net income you generated during the 2022 tax year. On the other hand, Medicare taxes get higher as your income increases. The 2023 rate is 2.9% on net income above $200,000 for individuals and $250,000 for married couples, and it isn’t capped. When it comes to the Medicare tax, the more you earn, the more you pay.
Who Owes Self-Employment Taxes?
According to the Internal Revenue Service, you are considered self-employed if you work as an independent contractor or the proprietor of a business. The same is true if you are a partner in such an endeavor. You’re also considered self-employed if you’re in business for yourself on a part-time basis.
By the way, there is no exemption for age or the fact that you’re receiving Social Security and /or Medicare benefits. Self-employment taxes will be assessed on net earnings of $400 or more for which an IRS Form 1099 was issued. Earnings from church employment are subject to self-employment tax if they exceed $108.27. Here, it should be noted that a net income of less than $400, while not subject to self-employment tax, must be reported just the same.
Quarterly Estimated Taxes and Self-Employment
The IRS mandates quarterly tax payments on self-employed individuals earning $1,000 or more during a calendar year. You could be hit with an underpayment penalty if you fail to make those payments. Frankly, though, it’s likely to be in your favor to pay quarterly.
Waiting until the end of the tax year to pay all at once could present a significant financial burden. Yes, you could ask for and receive a payment plan, however, that will just make matters worse the following year — plus you’ll pay interest on the amount carried over.
Tax year 2023 quarterly payments are due on April 18, June 15, Sept. 15 and Jan. 16, 2024. Monthly payments are also accepted through the Electronic Federal Tax Payment System.
Filing Self-Employment Taxes
The first step entails determining your overall tax obligation. It’s important to know the 1099 tax rate that will be applied to your income, as well as whether you’ll be subjected to taxes by the city and/or state in which you reside or do business.
Your tax rate can be calculated by figuring up the net profit or loss from your business. Subtracting the expenses related to your business from the income it generated will give you your net profit or loss for the year.
Generally, self-employment tax is applied to 92.35% of your self-employment net earnings. You’ll find the exact guidelines for this in the instructions the IRS provides for submitting its Schedule SE tax form for independent contractors and the self-employed.
Once you’ve determined your taxable income, the 15.3% tax rate should be applied to it to determine the amount of self-employment tax you’ll owe. Dividing the result by four will give you the amount of estimated quarterly self-employment taxes you should pay for 2023.
Self-Employment Tax Deductions
Okay, now for some good news. Half your self-employment tax is deductible from your personal income taxes. In other words, if after completing your Schedule SE you determine you owe $4,000 in self-employment tax, $2,000 of it can be deducted from the taxable income on your IRS Form 1040. Another deduction from which self-employed individuals can benefit is the qualified business income deduction, which can offset as much as 20% of your taxable income.
Expenses deemed “ordinary and necessary” to the operation of your business are also tax deductible. This could include commercial office space, a home office, vehicles, tools, equipment and any other items intrinsic to the functioning of your endeavor. Business and health insurance payments, continuing education and other costs can also be applied to reduce your tax burden.
While filing taxes when you’re self-employed is undoubtedly more complicated than doing so as an employee, there are a number of advantages to being self-employed. Chief among these is the fact that you are in control of your own destiny.
Now, with that said, working with a professional tax accountant offers a number of significant benefits. Tax laws can be quite complicated and a good professional will help you make sure you’re operating within its bounds.
They can also help you find all of the deductions to which you’re entitled.
