For some, working for yourself is the ultimate American dream. Unfortunately, this self-employment also makes your taxes a bit more complicated. As an independent contractor or business owner, you are required to pay the self-employment tax in addition to your standard income tax. We’ve put together a step-by-step guide to paying your self-employment tax to keep you within the bounds of the law and away from expensive fees and penalties.
Overview: Self-Employment Taxes
As its name suggests, the self-employment tax is a tax on individuals who own their own businessor contractors who otherwise make a significant amount of money (more than $400 annually) outside of a job. The self-employment tax is not a substitute for your annual income tax, capital gains taxes, or brokerage taxes. It is an additional tax that you are required to pay on top of these dues.
Do You Need to Pay a Self-Employment Tax?
To figure out if you must pay the self-employment tax, you’ll first need to figure out if you are self-employed. Generally, you are considered self-employed if you are an independent contractor, you carry on a trade or business by yourself or with a partner, or you otherwise earn more than $400 annually without the assistance of an employer. By law, independent contractors must maintain a large amount of freedom to avoid classification as an employee. The IRS states that independent contractors must have control over “what will be done and how it will be done” to retain their independent status. This means that if your client regularly requires you to be at a certain location while working, you are an employee—not a contractor. Telecommuting and remote employees who receive benefits and are eligible for worker’s compensation are not independent contractors, regardless of the fact that they are not required to be in a specific location when they work.
The Self Employment Tax Rate for This Year
For 2018, the self-employment tax rate is 15.3% of your total income—about 12.4% of that goes to Social Security and the remaining 2.9% is paid into Medicare. If you make over $128,400 annually, you will only have to contribute to Social Security on this amount—though you are required to pay into Medicare on the full amount of money that you have earned.
Step 1: Gather the Paperwork You’ll Need to File
The first step to paying your self-employment tax is to gather the necessary paperwork. This will help you figure out exactly how much you’ll need to contribute. Here's what you'll need depending on your status.
- Independent contractors: Collect a 1099 form from each one of your clients and your social security card or taxpayer ID number.
- Small business owners: Have a record of the profit you made in the previous years from an online spreadsheet service like Quicken or QuickBooks can help you easily keep track of what you’ve earned.
Step 2: Choose a Tax Provider or Tax Preparation Software
Self-employed individuals need to deal with a more complicated set of tax laws. It’s highly recommended that you work through a tax preparation provider, or you use a specialized set of tax prep software to handle your return. Your tax provider or tax preparation software can assist you in filling out a Schedule SE (Form 1040), which will help you specifically calculate the amount of money that you owe due to the self-employment tax.
Step 3: Understand Your Deductibles
After you’ve paid your self-employment tax, you’ll want to record the total amount of money you’ve spent separately. When you file your federal income taxes in April, you’ll be able to deduct half of what you paid as a deductible. Many self-employed individuals are surprised to learn just how many deductibles they’re eligible for. Some of the most commonly-missed deductibles for contractors and business owners include:
- Startup costs: If your business was formed this year, you can usually deduct the cost of getting up and running from your total income. These types of costs often include what you budgeted and spent on website and product development expenses as well as advertising costs.
- Home office deductions: If you work from home and you have a dedicated space that you only use for business, you may be able to deduct a portion of your home expenses from your income. The home office deduction commonly includes mortgage expenses, utility costs, and property taxes.
- Office supply deductions: Office supplies (which can include computers, leased software used for business purposes, and standard supplies like pens and papers) are almost always deductible.
- Health insurance deduction: Some self-employed individuals may deduct what they pay for health insurance for themselves and their families from their total income.
Keeping track of these expenses can help set you up for an easier (and less expensive!) tax season when filing your federal and state taxes.
Step 4: Remember to Set Up Estimated Quarterly Payments
As an independent contractor, you are required to make estimated quarterly payments into Social Security and Medicare—standard employees typically have these payments automatically deducted by their employers. To do this, you’ll need to fill out a Form 1040-ES, which is very similar to the Schedule SE (Form 1040). Filling out this form will authorize automatic withdrawals for your estimated taxes every three months. Don’t worry if your payments aren’t exact—if you make significantly more or less money at the conclusion of the year, a correction can be issued to adjust your payments in the form of an additional withdrawal or a return. Check out the following video for a more in-depth explanation of how to calculate your quarterly tax payments:
From investment taxes to self-employment taxes, it can be expensive to be in business for yourself. If you are self-employed, you should take every possible step to record all of your costs of doing business so you can accurately document your deductions. You may also want to consider opening a special retirement saving account for self-employed persons—a SEP IRA or solo 401(k) is often preferred by contractors and business owners over the traditional or Roth IRA thanks to higher contribution limits.