If are working as an independent contractor, freelancer, or you have started your own business, you are required to pay self-employment tax to the government. Self-employed individuals must consider their tax burden when planning to set their pricing or planning their finances for the year. They also need to track their business expenses and deduct them to get the taxable income. According to the Internal Revenue Service (IRS), self-employed individuals may be classified as an independent contractor, sole proprietor, or a member of a partnership that carries on a business or trade.
Self-Employment Tax Rate
Self-employment tax is comprised of Medicare and Social Security taxes and is taxed at a rate of 15.3%. This rate is divided into further with 2.9% for Medicare (hospital insurance), and 12.4% for Social Security which includes old age, disability, and survivors’ insurance. For the year 2019, the initial $132,900 of total wages, net earnings and tips were subject to taxation. The amount increased by $4,800 for the year 2020 where the initial $137,700 of combined net earnings, tips, and wages is taxed.
An additional tax rate of 0.9% on Medicare applies to compensations, wages, and self-employment income exceeding a threshold amount received in taxable years after 31st December 2012. People who use a different tax year other than the normal calendar year are required to use the tax rate and the limit on maximum earnings in effect at the beginning of their tax year. The same rate and limit should be used throughout your tax year despite a change in the tax rate or maximum earnings limit during your tax year.
How to File Your Taxes If You are Self-Employed
It is important to know your tax rate before determining your tax obligations and if your region requires you to pay separate city taxes. First, you need to calculate your net profit or loss by subtracting business expenses from your income. If you expect to owe more than $1,000 in self-employment tax, you need to make quarterly payments of the estimated tax.
Use Form 1040-ES if you want to make quarterly estimated tax payments. You will be required to fill your previous year’s return in Form 1040-ES, which has a similar worksheet to Form 1040. Blank vouchers incorporated in Form 1040-ES can be used to mail your estimated tax payments or you can make your payments online using the Electronic Federal Tax Payment System (EFTPS). It is important to estimate the amount of income you expect to earn if it is your first year as a self-employed individual.
You need to report your income or losses from a profession you practiced, or a business you operated as a sole proprietor if you want to file your annual return. You are required to file Schedule SE (Form 1040) to report your Medicare and Social Security taxes. To determine the amount of Medicare and Social Security taxes paid during the year, use the calculated income or loss on Schedule C or Schedule C-EZ. Schedule SE has useful instructions for filling out the form.
Tax Deductions and Tax Credits
Tax credits reduce the amount of taxes owed to the government while tax deductions reduce the total amount of your taxable income. Deductions decrease your tax bracket by lowering your taxable income and the amount of taxes you owe. Although every self-employed individual qualifies for the standard tax deduction, the amount deducted may vary based on your filing status e.g. single, head of household, married filing separately, or married filing jointly.
However, individuals sharing the same filing status are subject to a standard deduction amount. Some of the possible itemized deductions include state income taxes, property taxes, charitable contributions, student loan interest, mortgage interest, and state sales and local tax. However, each taxpayer is permitted to choose either itemized or standard deductions but not both.
Tax credits are classified under two categories; refundable or non-refundable. Non-refundable tax credits give you the ability to reduce your tax liability to 0. The refundable tax also presents the same option but the amount leftover from a refundable credit will show up on your remaining credit balance.
It is important to keep track of your business expenses if you want to be prepared for your tax obligations come tax season. Never wait to add up your expenses during the last minute, as you are likely to overload yourself with endless calculations. If you are self-employed and still have questions about your taxes, it is important to seek help from an accounting professional. You can also track the amount you are earning or spending using an accounting software package.