The Typical Withholding Scenario and Basic Tax Rates
Typically, the employer contributes 6.2 percent of your income (up to a maximum amount) into Social Security and 1.45 percent into Medicare; you pay the other 6.2 percent of Social Security tax plus 1.45 percent of your income for Medicare. Generally, your employer will deduct these amounts from your paycheck and forward them to the government along with its own contribution. When you’re self-employed, however, that task—as well as the full amount of the taxes—shifts entirely onto your shoulders. Currently, that means you have to pay 12.4 percent for Social Security and 2.9 percent for Medicaid. If you earn more than $200,000, for taxpayers filing as single, or $250,000, for married taxpayers filing jointly, you’ll have to pay an extra 0.9 percent for Medicare. In general, none of these taxes are considered deductible from your overall business overhead. This is the self-employment tax, and it does not take into account federal or state income taxes.
Determining the Amount of Tax You Owe
The actual amount that you must withhold for your self-employment tax is not based on your gross profit. Rather, it’s based on your net profit (or net loss). To determine this, you must subtract your business expenses from your business income. If your expenses do not exceed your income, you have a net profit. You can then calculate the precise amount of tax due using Form 1040.
If your expenses exceed your profit, however, you have a net loss. Generally, those losses can be deducted from gross income, and the self-employment tax is calculated on the same form. But the government limits the deductibility of losses in some situations. To see if you qualify to deduct a net loss, you must complete Schedule C, following the instructions in IRS Publication 334.
In some circumstances, you can carry over a nondeductible loss to another year, when it may be deductible. To determine whether your eligible to do this, you will need to review Publication 536.
The one exception to the limitations on deductions of net loss is for nonprofit organizations. Currently, the IRS does not limit the deductions nonprofits can take, nor do they restrict net loss applications for nonprofits, so long as the organization follows accepted business protocols for its industry.
Carryovers can be complicated, so it’s a good idea to speak to tax professional if you have questions.
Making Your Tax Payments
Because you’re self-employed, you’ll be expected to pay estimated taxes each quarter, as well as filing your annual return. Your quarterly estimated tax payments should include amounts to cover both your Social Security and Medicare tax obligations, as well as your estimated income tax bill. You can estimate the taxes due using the previous year’s return; as long as you pay estimated taxes at least equal to your previous year’s tax obligation, you shouldn’t owe any penalties. Estimated taxes are filed using Form 1040ES—Estimated Tax for Individuals. This form includes vouchers that you can print off and use to mail in your estimated tax payments throughout the year. You can also pay your taxes online with the Electronic Federal Tax Payment System, provided by the IRS.
As the year progresses, you need to make sure that your actual earnings match the projections you made in determining your estimated tax obligation. If you’re making less than you anticipated, and hence overpaying estimated taxes, then generally the government wants you to continue making the payments as you predicted. But if you’re making much more than you projected, you must make arrangements to make up the difference as soon as possible. Even if you make quarterly payments, you could be penalized if you pay less than 90 percent of the current year’s earnings and you also pay less than 100 percent of last year’s earnings.
If you are self-employed, you must file a Schedule C each year along with your Form 1040. The Schedule C is where you report your business earnings and expenses and calculate your net profit or loss. You’ll also include your estimated tax payments on the Form 1040, deducting them from your total tax obligation to calculate any remaining tax due. This amount should be sent, along with the tax forms, by April 15 each year.
As a general rule, it’s best to set aside your self-employment tax and all other estimated taxes as soon as you receive any business income, so you don’t have to come up with a large sum to make your quarterly and annual payments.
Getting More Help
If you need help with your self-employed taxes, or want to find out whether incorporating could reduce your tax liability, it’s helpful to speak to a business or tax attorney as well as an experience accountant.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.