Unless you grew up helping your entrepreneurial parents with their tax filing or you hang out with lots of tax professionals, you probably don't know how to file self-employment taxes. Filing taxes as a small business owner may seem more complicated than when you were an employee.
There's no human resources department to help you with withholdings. There's no payroll team to deduct the right amount from your paychecks. The responsibility falls on your shoulders to satisfy the Internal Revenue Service (IRS).
But that responsibility comes with opportunity. Think of it as a chance to develop sound business practices. Those practices help you manage your cash flow so you can make timely and accurate self-employed income tax payments.
To develop strong financial practices, it's key to know your self-employment tax rate, how to file self-employment taxes, and when to remit.
Here's an overview of what you need to know.
Taxes you pay on self-employment earnings
At first, it may seem like you pay more on your self-employment earnings than you would as an employee. You are — you pay both income tax and self-employment tax.
However, self-employment tax — what the IRS abbreviates as "SE tax" — covers Social Security tax and Medicare tax. So, in reality, you are paying close to what you would as an individual working for someone else.
But "close to" is also an important qualification. In the case of employees, these taxes are split between the employee and employer. For self-employed individuals, you pay it all.
So, how much is self-employment tax? It depends on how much you make. Here's what you may have to pay:
You pay this on 92.35% of your net earnings from self-employment. You do not have to claim self-employment income if your net earnings are less than $400.
Self-employed taxpayers pay 12.4% for Social Security and 2.9% for Medicare. The amount of your earnings subject to Social Security is capped every year, and that amount varies annually.
Additional medicare tax:
You pay an additional 0.9% if your total income, including self-employment and non-self-employment income, is over:
- $200,000 for a single person;
- $125,000 for a married person filing separately; or
- $250,000 for a married person filing jointly.
The self-employment taxes are included in your tax return and are not exhaustive of the overall tax you pay to the IRS. In addition, these are just federal taxes, and the total amount you pay depends on your self-employed tax deductions.
You are also responsible for state taxes, licenses, fees, permits and other charges levied by your region or municipality.
How to calculate your self-employment income
The IRS gives a simple explanation of how much you must claim.
First, self-employed individuals have to determine the amount of their net profit or loss by subtracting their business expenses from their business income.
If you have a profit of $400 or more, you must include that in your 1040 gross income.
If you have a net loss, you may deduct that loss. However, you can't deduct every loss or for an unlimited amount.
The basic steps for filing
At its most basic, here is how to file self-employment taxes step-by-step.
- Calculate your income and expenses. That is a list of the money you've made, less the amount you've spent. While you may have a 1099 form for some payments you've received as a contractor — a 1099 is like a W-2 — you may have to gather invoices for the rest.
- Determine if you have a net profit or loss.
- Fill out an information return. This is only required for certain types of payments or businesses. Visit the IRS website on information returns to see if it applies to you.
- Fill out a 1040 and other self-employment tax forms. These will include a Schedule C or Schedule C-EZ to report your income or loss. It will also include your Schedule SE (Form 1040), Self Employment Tax.
Since the paperwork can be lengthy and complicated, it’s helpful to use a tax software or have an accountant or certified public account (CPA) to help with tax preparation and review your documents before submission. (Bonus: getting an accountant’s help is deductible!)
Can you use an optional method?
Suppose your net self-employment earnings were less than $5,880, and those earnings accounted for no more than 72.189% of your gross overall income. If so, you can use an optional method to calculate tax. The effects of this choice are outlined on the IRS' instructions for form Schedule SE.
When to pay taxes: estimated tax payments
Another thing that works a bit differently is when you pay your taxes. Most self-employed people have to make quarterly payments, estimating the amount they will owe throughout the year. See the IRS’s estimated tax payment schedule.
You can use IRS form 1040-ES to figure out your quarterly tax payments. The form also has vouchers you can use to remit the amount owing to the agency.
Staying updated on self-employment taxes
Knowing the nuts and bolts of paying self-employment tax is one thing. Integrating that knowledge into the daily operations of your business can be quite different. Here are some useful tips:
Pay your taxes in full and on time
While filing taxes quarterly is no party, it’s far better to feel the pain of taxes regularly than to put it off and end up with a huge bill from the IRS.
Ask for help
An accountant or financial advisor can help relieve the burden. If you’re not confident in how to file self-employment taxes, partner with a professional who can show you how.
Include taxes in your budget
Set aside the amount of taxes you'll have to pay, so the money is available when the bill is due. Budget for 25-40% of your quarterly profit to be safe.
Keep all receipts from business-related expenses
The IRS lets you reduce self-employment tax by deducting expenses. Keep track of everything you spend throughout the year. Your receipts, mileage and even vehicle depreciation can all be used for tax purposes.
Deductible expenditures include business insurance, health insurance premiums, vehicle, and use of your home if they are legitimately part of your self-employed expenses. These deductions can help you reduce your overall taxable income.
Minding the details of your business
Paying self-employment taxes likely means you've made a profit on your business. To keep that positive aspect going, remember to mind all of your operation's legal and administrative aspects.
That means paying taxes, keeping your license and certifications up-to-date, understanding your contractual obligations to partners and clients, and holding business insurance to keep you protected.
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