Being self-employed means you carry the business on your back. All profits funnel to you, but so does the tax burden. The self-employment tax rate sucks the fun right out of being your own boss. But it isn’t so bleak when you know how to treat SE earnings so you save on taxes. Breeze through your Schedule C and important tax deadlines with this brief.
In this article:
- Who is self-employed?
- Tax burden of self-employment
- What is SE tax?
- How to calculate self employment tax
- What is a Schedule C?
- Tax deductions vs tax credits
Who Is Self Employed?
If you are in business for yourself and are not working for any employers. This includes independent contractors who are issued 1099’s. Self-employment could be a part-time or full-time work schedule. As well as, categorized as any one of these tax structures: sole proprietor, a partnership, and LLCs.
What Qualifies Business Activity?
You need to pay taxes on business activity. Self-employment activity is qualified if it is done with the intent to make income or profit. It is any activity that you engage in regularly, not sporadically. The income is considered business profit and is detailed on a Schedule C.
Tax Burden Of Self Employment
As a self-employed individual, you are responsible for all taxes related to your business. Your net business earnings are subject to these taxes:
- Federal/State Income Tax
- Federal Self Employment Tax (Social Security and Medicare)
- State Sales and Use Tax (if you are purchasing goods and services)
- Payroll Taxes (if you have employees)
Income Tax On SE Earnings
Depending on your SE earnings, income tax follows brackets ranging from 10%- 37%. If you are married or jointly filing your income bracket changes, increasing what you owe. Self-employed individuals also owe the state taxman. Depending on the state you live in you’ll pay according to local income tax brackets, or a flat income tax rate.
What Is SE Tax?
Self Employment Tax (SE Tax) is a tax to your net income that funds Social Security and Medicare. The total tax rate is 15.3%, breaking down to 12.4% for Social Security, and 2.9% for Medicare. Typically when you are employed by someone, that employer would pay half (7.65%). The other half (7.65%) would be withheld from your wages and remitted to the government by your employer. Since you are self-employed, you pay the entire amount if you earn $400 or more in net SE earnings. Self-employment taxes are reported on a Schedule SE.
Gross Income: Income before all taxes or deductions
Net Income: Income after business expenses
Self Employment Tax Examples
For Social Security, the 12.4% tax rate is capped at $142,800 in earnings (this number changes every year due to inflation). So if you make above that you will be taxed the maximum amount.
For example: you earned $150,000 for the year. You would owe (142,800 x .124) = $17,707.20 for Social Security.
For Medicare, there is no wage cap. You pay 2.9% on earnings up to $200,000 as a single filer and $250,000 as a joint filer. Any earnings beyond that are taxed an additional .9%. The Additional Medicare Tax even applies if you are joint filing and part of the income is not from self-employment.
For example: you and your spouse earned $350,000 combined income. You would owe ($250,000 x .029) + ($100,000 x .009) = $8150 for Medicare.
Estimated Tax Payments
If your tax liability is going to be more than $1000, you need to make estimated payments. These are prepayments based on an estimated income for the year. You calculate your income using the previous year’s business activity. Estimated payments are paid at the Federal, state, and local tax levels.
There are two ways to pay estimated taxes to the IRS. You can make 1 lump estimated payment for the upcoming year, on the due date of the current year’s taxes. Or you can make 4 quarterly installments throughout the current year. Pay schedules are different at the state level, you will need to check your local tax rules. Note: Self-employment taxes need to be included in your estimated tax liability!
Follow a tax plan, otherwise, you could be fined. There is a Federal tax underpayment penalty for not paying enough throughout the year. You must pay at least 90% of your tax liability in estimated payments in the current year or 100% in tax liability of the previous year. Accountants make it a habit to pay 110% in estimated tax payments to cover any sudden jumps in income and avoid penalties.
What Is A Schedule C?
We will be focusing on self employers that pay business taxes with Form Schedule C. Sole proprietors, single-member LLCs, and independent contractors all use a Schedule C. Basically, any business filing with a 1040 or 1040-SR, will use this form to detail profit and losses of a business.
Ordinary And Necessary Self Employment Expenses
To arrive at your net self-employment income, you need to deduct expenses. The more expenses you deduct, the more your taxable income decreases, the less self-employment tax you will owe. Be careful though, not all business expenses are tax-deductible. The expense has to be ordinary or necessary to be considered tax-deductible.
Ordinary Expense: An expense that is common and accepted in your trade or business.
Necessary Expense: An expense that is helpful and related to your trade or business.
Ordinary and necessary expenses cannot be outside the scope of your business activity. Personal expenses never qualify as something that is tax-deductible. Although, certain expenses that are used for business and personal, can be expensed. These expenses usually have a limit to how much can be deducted.
Tax Deductions vs Tax Credits
You are entitled to additional tax credits and deductions to your SE earnings. Both deductions and credits lower the amount of tax you pay. So what is the difference? Deductions will reduce your taxable business income, credits reduce your tax liability. Deductions are taken before you can redeem tax credits.
Tax credits come in two different flavors: refundable and non-refundable. Refundable is a sweet deal because you get money even after your tax liability has been cleared. Non-refundable means that you will not be able to redeem any money for a tax refund. Note: When you are a high-income earner, no amount of credits or deductions will erase your tax dues. If year by year you owe zero in taxes, that is concerning and warrants a consultation with a tax accountant.
Schedule C Expense Deductions
Throughout the year you should be itemizing your business transactions into an accounting system. Come tax time you can quickly transfer expenses into your Schedule C. These are the most common items we see self-employed individuals use for expense deductions.
Payroll – Line 26
If you have W-2 employees you may deduct the wages you paid here. Note: You cannot deduct your personal salary here, nor include any employment credits you are receiving from the government (ie Work Opportunity Credit).
Contractors – Line 11
Any 1099 contract work goes here.
Commissions and Fees – Line 10
If you pay commissions to your employees or paid for any work-related services to businesses, report it here.
Employee Benefits – Line 14
Enter the amount you pay to employee benefits like health insurance, disability, life insurance, etc.
Home Office – Line 30
The percentage of your home that your office occupies plus rent payments, mortgage interest, and property taxes. It has to be a space that is exclusively and regularly used as a business office. Note: for the Simplified Square Footage Method you multiply the rate by the square footage of your office, up to a 300 sq ft space.
Property and Equipment – Line 20
If you purchase or repair equipment used to generate income, it is deductible. Note: when equipment is used longer than a year, you need to set up a depreciation schedule and deduct a certain amount every year for its useful life, when you do this it goes on Line 13
Vehicle Expenses – Line 9
You can deduct business use of a vehicle plus expenses like car payments, gas/charging, repairs car insurance, parking, tolls, license fees. Note: if you are taking the standard deduction keep a mileage log of your business trips, to multiply total miles by the standard mileage rate.
Travel and Meals – Line 24
Jettisoning off for a client meeting or work-related endeavor should be deducted. Airfare, hotel, and anything during the trip that contributed to your business can go here.
Self-funded IRA Deduction – Schedule 1 Line 15
By contributing to an IRA you can take a deduction. You can retain up to 25% of your SE earnings depending on the type of IRA account you have. These are pre-tax accounts and you can deduct them against your gross income. You are only subject to pay taxes once you pull out the money in retirement.
- Simple IRA: you can deduct up to $13,500 in contributions (subject to changes)
- SEP IRA you can deduct up to 25% of your wages capping $58,000 (subject to changes)
Health Savings Accounts (HSA) Contributions – Schedule 1 Line 12
A health savings account (HSA) is like a 401(k) plan for your health. They are available to people with high deductible healthcare plans as a way to plan for major health events. Contributions to the account are not subject to federal income tax. You can deduct a maximum amount of $3600 for an individual and $7200 for a family using Form 8889
Qualified Business Income (QBI) Deduction
Take full advantage of the qualified business income tax deduction using Form 8995. It is available to any pass-through entity reporting taxes on individual tax returns. The QBI deduction is 20% off net business income for single filers making under $164,900, and married couples or joint filers making under $329,800. The Tax Cuts and Jobs Act greenlighted this deduction through 2025.
Self Employed Tax Deduction
SE tax on your income is quite the slice in your pie. Get a break with the Self Employed Tax Credit, and deduct half of your self employment tax payments as a business expense. Note: you will still need to pay the full amount of self-employment tax in estimated payments, and report them on Schedule SE. When your annual return comes around that is when you deduct half of your SE tax payments. This goes as an adjustment to your gross income on Schedule 1 Line 14.
How To Pay Less In Taxes
Tax deductions and credits will help minimize taxes on your SE earnings. That isn’t a reliable method for tax savings. As a self-employed individual, you are at the whim of changes to tax law. The best way to reduce your business taxes is to change your business structure. Consider restructuring by making an S election to see the biggest difference in your tax bill. Schedule a call with our tax expert and see how you could permanently get half off SE tax.