Self-Employment Taxes: Here’s What You Need to Know

More and more people - especially single moms -  are working multiple jobs or side gigs to make ends meet. But not all of those jobs come with a “normal” paycheck, the kind with taxes taken out. And that's why you need to know about self-employment taxes.

When you work as a freelancer or independent contractor, have your own business (no matter how small), or have a side gig where you’re not an official employee, you are self-employed…and that means you’ll probably have to pay self-employment taxes.

Self-employment taxes are really just Social Security and Medicare taxes, also called payroll taxes. When you have a regular W-2 job, you and your employer split those taxes: you pay half, they pay half.

But when you work for yourself, you’re the employee and the employer, so both halves of that tax fall on you.

And you have to pay self-employment taxes in addition to regular income taxes.

The earnings test for self-employment taxes

$400 – that’s the level where these taxes kick in. If your business earns at least $400, you’ll be on the hook for self-employment taxes… but that $400 comes with some wiggle room. Because when you're self-employed, you count as a business. And that means you can deduct business expenses from the money you make.

So, if you made $800 doing your side gig but you had $450 of expenses, you’re earnings would only be $350 – no self-employment tax payment necessary. In that same situation but with only $50 of expenses, you’d pay self-employment tax on your $750 earnings. That's why you want to make sure to account for every possible business expense, and keep your tax bill as small as possible.

What kind of things can you deduct? It really depends on the type of business you’re running, but most businesses have at least some of these common expenses:

  • Office supplies
  • Postage/delivery services
  • Internet
  • Phone
  • Utilities
  • Business mileage
  • Rent

Retirement plan contributions are also tax deductible here, so stash as much cash away as you can. Women, especially single moms, tend to blow off retirement savings – that’s a HUGE mistake. Even if you can’t afford to save very much, put away something - anything! -  every month toward your retirement. You can commit to bigger contributions once you have more financial flexibility.

And don't forget to figure out your home office deduction when you’re adding up your expenses.

Your business structure affects your self-employment taxes

Another factor that plays into self-employment taxes: your business structure. Every business has a legal structure. Most self-employed people (like freelancers) count as sole proprietors, meaning they work alone  and haven’t set up a more formal business. The next most popular business form is the single-member LLC, which still counts as a sole proprietorship for tax purposes. Either way, you’ll fill out Schedule C, Profit or Loss from a Business, when you do your taxes at the end of the year... and you'll have to pay self-employment taxes.

If you work together with someone else and haven’t set up anything formal or you have a multi-member LLC, you count as partner for tax purposes. Partnership taxes and tax returns are more complicated, so you’re best bet is to work with a tax pro.

Whether your business is set up as a sole proprietorship, a partnership, or an LLC, you have to deal with self-employment taxes personally, because you don’t get an official paycheck as an employee of the company.

How to do the math for self-employment taxes
The math for figuring out your self-employment tax is a little wonky because there are two separate parts, and you have to deduct the tax before you calculate the tax. I know it sounds complicated and a little ridiculous, because it is, but just stick with me here.

Like I mentioned before, self-employment tax is really just Social Security and Medicare taxes. Here’s the breakdown:

12.4% Social Security tax rate, which applies only to the first $142,800 of earnings. If you earn more than that through your business, or from a combination of a business and a “regular” job, this tax stops.

2.9% Medicare tax rate, which gets applied to unlimited income.

15.3% total self-employment tax rate on the first $142,800 of earnings, your company’s net income.

Here’s the wonky math part. Your business gets a deduction for the “employer” portion – half of the 15.3% – of these taxes. To account for that, you’ll multiply your net income by 92.35% (0.9235).

Next, multiply that result by 15.3%. The instructions for this are right on the tax form you’ll use to report your self-employment taxes, IRS Schedule SE.

Here’s an example
• You have a virtual assistant business set up as a sole proprietorship.
• In 2021, your business has net income of $40,000.
• Your net income for SE tax purposes is $36,940 ($40,000 x 92.35%)
• Your SE tax for 2021 would be $5,651.82 ($36,940 x 15.3%)

If you use tax software (like Turbo Tax), it will take care of all these calculations for you – but it’s still always good to know how to figure it out yourself.

How self-employment taxes fit in your tax return

When you have your own business operating as a sole proprietorship or a single-member LLC, your tax return will include a couple of extra forms: Schedule C and Schedule SE. Those forms flow right into the main tax form, Form 1040 by way of Schedule 1 and Schedule 2.

You also get to subtract half of the self-employment taxes you paid from your taxable income. That deduction reduces your adjusted gross income and the total amount of income taxes you’ll owe.

Have questions about all of this? Contact me here.

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