How are self employment taxes calculated
Introduction
Being self-employed offers numerous perks such as increased flexibility and autonomy. However, it also comes with the responsibility of understanding self-employment taxes. Self-employed individuals must pay both income tax and self-employment tax on their earnings. This article will walk you through the process of calculating self-employment taxes and help you better prepare for this financial obligation.
1. Understanding Self-Employment Taxes
The self-employment tax is essentially the Social Security and Medicare taxes combined, also known as FICA (Federal Insurance Contributions Act) taxes. When you are an employee, your employer would typically withhold these taxes from your paycheck and match the contributions. As a self-employed individual, you are responsible for covering both portions of these taxes.
2. Determining Your Net Earnings From Self-Employment
Before calculating your self-employment taxes, you need to determine your net earnings from self-employment. This requires subtracting any business expenses from your gross income.
Net Earnings = Gross Income – Business Expenses
Remember to keep all receipts and records for your business expenses, as they will be crucial when filing your tax returns.
3. Calculating Your Self-Employment Tax
Once you have determined your net earnings, you can use a two-step process to calculate the total amount due for your self-employment tax:
Step 1: Determine the taxable portion of your net earnings
Multiply your net earnings by 92.35% (0.9235). This adjustment accounts for the fact that as a self-employed person, you are responsible for covering both the employee and employer portions of FICA taxes.
Taxable Net Earnings = Net Earnings * 0.9235
Step 2: Calculate FICA Taxes
Apply current FICA tax rates to your taxable net earnings calculated in Step 1:
Social Security Tax = Taxable Net Earnings * 12.4%
Medicare Tax = Taxable Net Earnings * 2.9%
If your earnings exceed certain thresholds, you may also be subject to an Additional Medicare Tax of 0.9%.
Total Self-Employment Taxes = Social Security Tax + Medicare Tax
4. Additional Deductions
The IRS allows self-employed individuals to deduct the employer-equivalent portion of their self-employment tax when calculating their Adjusted Gross Income (AGI) on personal income tax returns. This will reduce your overall taxable income.
5. Paying Your Self-Employment Taxes
To avoid penalties, self-employed individuals should make quarterly estimated tax payments throughout the year in order to cover their income tax liabilities and self-employment taxes.
Conclusion
Calculating and paying self-employment taxes may seem overwhelming at first, but understanding how the process works can help you better manage your financial obligations while enjoying the benefits of being your own boss. Make sure to consult with a tax professional if you have additional questions or need further assistance in handling your specific situation.