Self-employment

Self-employment tax is what self-employed individuals and small business owners pay to the federal government to support Medicare and Social Security. While employers handle these tax calculations for most employees, self-employed individuals must figure out their own SE tax using Schedule SE (Form 1040 or 1040-SR). 

Unlike employees, self-employed individuals can't deduct Social Security and Medicare taxes. 

How does it work? 

If you make $400 or more a year from self-employment, including side gigs, you must pay Social Security / Medicare taxes, otherwise known as FICA taxes, on any income over $400. These taxes contribute to your future Social Security and Medicare benefits and are essential to comply with IRS regulations for self-employed individuals. 

The current self-employment tax rate totals 15.3%, with 12.4% allocated to social security (covering old-age, survivors, and disability insurance) and 2.9% to Medicare (hospital insurance). 

There are strategies available to lower this 15.3% tax burden for businesses potentially:

• Deducting business expenses can significantly lower your tax bill because self-employment taxes are based on your net earnings rather than your total income. It's essential to carefully track all deductible expenses and explore potential tax credits to maximize your savings. 

• Some LLC members can lessen their self-employment tax obligations by taxing their LLC similarly to an S corporation. In an S corp, owners pay Social Security and Medicare taxes solely on their wages, whereas LLC members pay self-employment taxes on all their share of the LLC’s profits. However, opting for S-corp status isn't suitable for everyone. Consult with a tax advisor to assess if it's the best decision for your situation.

• Self-employed individuals can deduct half of their total self-employment tax as an above-the-line deduction, corresponding to the employer's portion of Social Security / Medicare contributions in traditional employment. Simply divide your calculated self-employment tax by two and enter the result on line 15 of Schedule 1 with your Form 1040. 

Calculating your AGI, you can subtract the employer portion of the self-employment tax. This deduction impacts your income tax but does not change your net income derived from self-employment or the SE tax. If you file a Schedule C with Form 1040 or 1040-SR, you might qualify for the Earned Income Tax Credit (EITC).

You must pay self-employment taxes and submit Schedule SE with your Form 1040, usually by April 15. However, you must make estimated quarterly tax payments if you anticipate owing $1,000 or more in total income tax and self-employment taxes. These tax payments are generally due on Apr 15, Jun 15, Sept 15, and Jan 15 of the following year. If these dates fall on a weekend / holiday, the deadline date shifts to the following business day. 

Self-employed individuals must disclose their income and expenses on their annual tax filings. Certain forms that may be necessary to submit alongside your annual return include:

1099 NEC: Companies that hire you as an independent contractor will provide you with this self-employment tax form. The 1099-NEC form reports income from non-employee work, which you'll include as self-employment earnings on your annual tax filing.

1099 MISC: If you earn income from rental payments or royalties, this information will be reported to you using Form 1099-MISC.

Form 1040: Your annual federal tax return documents all income sources, including earnings from self-employment. As a self-employed individual, you must complete specific schedules tailored to your business.

Schedule 1: This additional schedule details various types of income and adjustments, such as business earnings. It also includes the deductible portion of your self-employment tax, which is transferred to Form 1040.

The schedule outlines the income and expenses associated with self-employment, reflecting the profit or loss from your business activities.

Schedule SE: Calculates Self-employment taxes.

Form 8829: If you're eligible for a home office deduction, this is where you'll calculate the amount you can claim on your taxes. 

Consider making estimated quarterly tax payments using Form 1040-E to avoid IRS penalties.

Takeaways

The rules for self-employment tax apply regardless of age, even if you're already receiving Social Security or Medicare benefits. Self-employment tax, part of income tax, encompasses Social Security and Medicare taxes. Unlike regular employees, who have these taxes withheld from their pay by employers, self-employed individuals must calculate and remit these taxes themselves, ensuring accurate payments each year. 

Fun Fact: Did you know that self-employed individuals can deduct the employer-equivalent portion of their self-employment tax when calculating their adjusted gross income? This means you get a bit of a break for being your own boss!

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