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Small Business

Self Employed Tax Withholding Explained

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By Next Insurance Staff
Jun 2, 2020 min read

With business ownership comes a whole new set of responsibilities, and one new wrinkle you’ll absolutely need to get a handle on is self-employment tax rules. 

Having a general idea of how to calculate self-employment tax will help you as you move through the year, and forecast how self-employed tax withholding might affect your cash flow and profits. These processes will differ substantially from the methods used by your former employer to assure that your tax obligations are squared away with the federal government. 

Whether you’re filing taxes as an independent contractor or new business owner, the first piece of advice you’ll want to heed is enlisting the help of a certified tax professional to make sense of self-employment tax amounts and how the federal income tax rates for self-employed entities determine those amounts. By the same token, some self-education never hurts when gauging how much tax to withhold if self-employed, and that endeavor can help you stay on the same page with an accountant tasked to sort it all out for you. 

A General Look at Tax Withholding 

It’s highly likely you’ve worked for someone else in the past, so you’re undoubtedly familiar with how tax withholding impacted your paycheck. 

Your former employer deducted amounts each pay period from your gross wages or salary and those dollars were remitted by the company to federal, state and local revenue agencies to fulfill your obligations. At year’s end on up to April 15th, you’d receive a W-2, which summarized those deductions and created a report by which you’d calculate if you owed money or could expect a refund from the IRS. 

Now that you’re in business for yourself, self-employment tax rules take on a different form and filing process. Essentially, you are your own employer and there will be no one to mind the tax withholding shop, if you will. You will have the right to take advantage of small business tax deductions, so most all expenses incurred in your business pursuits will reduce your taxable income and that’s the starting point for self-employment estimated tax payments. Each fiscal quarter, you may need to pay an amount to the IRS that reflects your share of federal income tax for self-employed that’s due. 

Properly Managing Taxes and Cash Flow

It’s been said that there are only two certainties in life, and neither of them is avoidable. Thus, strategically planning for what you will ultimately owe to the federal government at year-end makes good fiscal sense from a couple of angles. 

Self-employed quarterly tax payments give you the opportunity to make four payments throughout the year rather than forking over a big bundle of cash when a final tax return is due. Naturally, your revenue may change from year to year so the best practice you can adopt is to calculate my self-employment tax payments on the basis of past earnings, and perhaps add a cushion in for potential revenue growth. 

On the other side of the equation, you also have a right to apply small business tax deductions against gross revenues, and a little foresight can make the difference between a big tax bill and a reasonable one. As the year progresses, you may determine, through self-analysis or a consultation with your accountant, that an investment in the business may help boost your competitive advantage and reduce your taxable income. For example, purchasing a piece of capital equipment or vehicle toward the end of the year, if feasible, will provide you with a considerable tax deduction and a potentially smaller tax payment to the IRS.

How to Calculate Estimated Tax Payments 

Calculating estimated tax payments isn’t an exact science, so the best practice to adopt is following the guidelines set forth by a tax professional or the amounts generated by tax-filing software, if you complete your own tax return. 

Here’s a method of figuring how much you might want to pay throughout the year. Note that deadlines for estimated payments fall on April 15th, June 15th, September 15th, and finally, the last estimated payment will be expected on January 15th of the following calendar year. 

Looking back on the previous year will be your best benchmark for calculating a self-employed tax amount. And you’ll want to get it right because you could incur an IRS penalty for underpaying self-employment tax estimated payments. Along with self-employed federal tax rates that range from 10% through 37%, be sure to account for Social Security and Medicare taxes combined that amount to 15.3% of net income for 2019. 

Let’s assume you had to pay $24,000 in the previous tax year or $6,000 four times throughout the year. In this example, you’ll want to set aside the same dollar amounts at a minimum to pay the IRS on those prescribed dates. It’s entirely possible that you may have a great year sales-wise and your overall obligation to the taxing body will be $30,000 for the year. This will leave you with an additional amount of $6,000 owed when filing a final business return and a possible underpayment penalty from the IRS. However, as long as you match your estimated payments from the previous year, no penalty will apply. 

Staying on Top of Tax Obligations 

When it comes to knowing how much tax to withhold if self-employed, the first step is implementing a sound bookkeeping strategy. 

Whether it’s your responsibility as a sole proprietor or you’re able to delegate duties to an employee or partner, maintaining accurate records of income and expenses will go a long way toward assessing self-employed tax withholding and federal income tax rates for self-employed operations. Stay abreast of deductible expenses and also realize that non-deductible expenses for business factor into the mix as well.

Managing taxes is crucial to keeping your fiscal affairs in order. It’s one of the many areas you’ll need to focus n when running a business. To protect your business interests and your profits, securing business insurance will insulate you from perils that threaten your existence as a small business. Contact Next Insurance to find out how our comprehensive insurance plans will do just that.

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By Next Insurance Staff
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