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Author: bmotrader   |   Latest post: Tue, 13 Oct 2020, 5:12 AM

 

How Are Taxes Different for the Self-Employed?

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Tax season is most people’s least favorite time of the year. After all, who likes to lose a portion of their hard-earned money? However, taxes remain a big part of your obligations as an American citizen. In general, filing tax returns is not something that a lot of people are skillful at, hence why they usually hire tax preparers to help them out. Although being self-employed comes with plenty of benefits, it is not without its drawbacks. As a self-employed individual, this whole process can get even trickier. Don’t fret, though, because understanding how taxes are different for the self-employed is not as hard as it sounds at first. If you are interested in learning about SE (self-employment) taxes, read on for more insights.

Who Is Considered Self-Employed?

Before we delve deep into the nitty-gritty details of how taxes are different for the self-employed, you need to know whether you fall into this category in the first place. According to recent statistics, there are around 16 million self-employed Americans, so there is a big chance that you are one of them. Based on the IRS’s definition, there are 3 types of self-employed individuals: independent contractors, people involved in partnerships that operate businesses, and people who do not have employers (think freelancers). Veterinarians, doctors, dentists, and lawyers can all be considered independent contractors. However, this is not always the case. An easy way of figuring out whether you are an independent contractor is to take a look at how you usually perform your work tasks. If you have complete control over how you do your job, then you are an independent contractor.

What Taxes Do You Have to Pay?

Now that you are sure that you are indeed self-employed, let’s talk about specifics. Self-employed individuals are obligated to pay two main types of taxes: income and self-employment (SE) taxes. As you must already be familiar with income taxes, we are going to cover the SE tax. This tax has to do with Medicare and Social Security. Regular employees get Social Security and Medicare taxes directly deducted from their salaries. To avoid confusion, think of SE tax as Social Security and Medicare taxes but for the self-employed. So, same concept, different names!

What Is the Purpose of Quarterly Payments?

Generally speaking, regular employees do not have to worry about Social Security and Medicare taxes as their employers withheld them from their wages. Because you do not have an employer, you have to adhere to a different payment system. The system mandates that you need to pay your taxes throughout the year. The reason behind this is that you do not get tax refunds during tax season. If you do not know what you are doing, you are certainly going to be stressed about the SE tax. Nevertheless, they are easy to master once you get to learn the ropes of how they are calculated.

How to Calculate Self-Employment Taxes?

We’ve finally reached the meat of the article. Yet, before you open an Excel sheet and get ready to calculate your SE tax, you need to make sure that you are not exempted from paying them. Yes, surprisingly, not all self-employed people are required to pay SE tax, but they are few and far between. First off, if you had no tax liability the previous year, you are exempt from SE tax. The term “tax liability” refers to the amount of taxes you owe the government. So, if this amount was zero last year, you do not have to worry about SE tax. Of course, this is an extremely rare scenario. If you estimate that you will pay less than $1000 a year in SE tax, you are exempt as well. Landlords who are not real estate professionals and business owners whose companies function separately from them are not considered self-employed. The profit they receive is called “passive income,” which is not subject to SE tax.

 

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According to the IRS, the SE tax’s rate as of now is 15.3%: 12.4% for Social Security and 2.9% for Medicare. When it comes to Social Security taxes, only $137,700 of your income is taxable. That said, depending on the situation, you may have to pay an extra 0.9% Medicare tax if you make more than $200,000. To accurately calculate how much you need to pay, you need to know your annual net earnings. The easiest way to do this is to subtract business-related expenses from your aggregate income. Then, you can apply the 15.3% rate to know the sum you owe the government. If you have trouble applying this formula, there are many online calculators you can use, provided that you have been keeping track of your income and business costs.

What Are Your Payment Options?

So, you have calculated your taxes, now what? It is time to pay what you are due, of course! When it comes to the question of how to pay estimated quarterly taxes, there are many methods you can try. First off, you can pay them electronically through Direct Pay, a service that the IRS offers. If you usually use checks, rest assured that they are a viable option as well. You do not have to worry about payment methods, as the myriad of options available accommodates the needs of all taxpayers.

What Deductions Can You Get?

Deductions are the holy grail for most taxpayers. As a self-employed person, there are 15 deductions you can go for. These relate to business expenses. For example, you can get a deduction if you have a home office. Similarly, using your car for business also gives you a deduction. You may be able to reduce the sum you are due to pay, in case you have high internet and travel costs as well.

 

Self-employment is a great option for those who want to set their own work hours and choose their clients. However, we cannot deny the extra responsibility this variety of work comes with. Filing returns and paying taxes can be a headache when you are an independent contractor. Hopefully, now you know a bit more about how taxes are different for the self-employed. To spare yourself much hassle, we recommend that you hire an accountant to take care of everything. In any case, keeping a close eye on your profits and expenses can go a long way towards helping you calculate your taxes accurately.

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