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Learning All About Self Employment Taxes

Self Employment Taxes Michelangelo David

All of my life I have been a W-2 employee.  I would get a paycheck and my taxes would be taken out.  After time and research I understood my investment shelters like my 401K, H.S.A., and IRA.  In 2019 all of this changed. I’m self employed. I get to learn a new language. Let’s take a look into what I have learned about self employment with respect to taxes.  It’s all new to me my friends.

Disclaimer:  I’m not a CPA, while I consider myself a personal finance nerd that doesn’t mean any of what I’m going to share is actual advice.  Instead consider the remaining part of this article witty banter about self employment taxes. Go on just pretend I know almost nothing and I’m learning.

Self Employment Taxes

For those of you who are loyal followers here at Even Steven Money, first off many thanks!  Second, you  know that I didn’t start making money hand over fist when I started the year. In fact, I told the story and  made it into a 3 part series.  Check out “A Year without Income, “The First 6 months are the Hardest”, and “An object in motion tends to stay in motion”.

So this really is all new to me.  Also my self employed income is coming from work through the website, my business as a money coach, but also working as a 1099 self employed contractor.

Self employment is new enough for me that I had to start figuring out how to pay taxes.  I do understand the basics. Make money, pay taxes.  

I had to ask myself a simple but insanely difficult question.  How much tax do you pay if you are self employed? Let’s take a look.

Self Employment Taxes Small Business Store Open for Business

As a money coach, my business is always open. No doors though, always forget if I need to push or pull.

How much tax do you pay if you are self employed?

I started with the IRS website.  They won’t tell you a story and make self employment taxes fun and easy, but it’s the best place to start.  The first information they share is the most important, let’s highlight this.

“It should be noted that anytime self-employment tax is mentioned, it only refers to Social Security and Medicare taxes and does not include any other taxes that self-employed individuals may be required to file. The list of items below should not be construed as all-inclusive. Other information may be appropriate for your specific type of business.”

Basically they are saying this is what you MUST pay if you are self employed.  If you had a W-2 job in the past like me this was already automatically deducted from your paycheck, your employer even paid some of the taxes, but more on that in a minute.

What is Self Employment Tax?

OK so we learned that we MUST pay taxes on our income, but what is the self employment tax that we need to pay?

“Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.”

Right so this is what I mentioned a little from above in regards to what is deducted as a W-2 employee.  Except now you are in charge of paying it on your own. Social Security and Medicare taxes are what I am responsible for.  Simple enough, got it. Wait how much in taxes do I need to pay?

Self Employment Tax Rate

The simple answer is a total of 15.3%.  Taxes are not usually simple so here’s a little more.  The social security tax is 12.4% and the Medicare tax is 2.9%.  

Right so I just take what I earn and pay 15.3% of that in taxes?  Not exactly remember taxes are complicated, this is just the start.

I’m not going to bore you, but there is a ton of details involved even in this cut and dry 15.3% rate the IRS provides. For example if you are a railroad worker, earn above the threshold income, and additional Medicare tax are all possibilities that twist and turn down a different road on what to do next. 

There is a reason I hire a CPA for my taxes.

So is that all I need to know about self employment taxes?  

Italian Beer Bellagio

Go ahead grab a beer, taxes are not easy

No.  Taxes prefer to laugh in your face.  This is like the 101 of self employment taxes, actually is there a 001 because truthfully we are just scratching the surface.  There is always more. Here are a couple of quick observations from the IRS website.

Pretty much everyone needs to pay self employment taxes.  If you make $400 or more, pay the man. Also it says to file schedule SE 1040.  Honestly I know anything about this form. I will say this statement from the IRS website is moderately helpful and also confusing.  Great right!

Generally, your net earnings from self-employment are subject to self-employment tax. If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C or C-EZ to figure net earnings from self-employment.

If you have earnings subject to self-employment tax, use Schedule SE to figure your net earnings from self-employment. Before you figure your net earnings, you generally need to figure your total earnings subject to self-employment tax.

It’s a little confusing for me so this is where I started reading more articles and asking more questions.  But it’s a start, right!?!?

Figuring Out Self Employment Estimated Taxes

At this point we know that we MUST pay taxes and it’s 15.3%.  The IRS however expects everyone to pay these taxes on a quarterly basis.  Not only that but they also want us to estimate what we are going to owe. IRS you guys!  Always trying to have the most fun in the whole government.

I did what any personal finance nerd would do and I again went to the IRS website. How else am I supposed to know that estimated taxes are different for farmers and fishermen.  As you can see some of this is not applicable.

Who Must Pay Estimated Taxes

A short time ago, I freaked out.  Money was coming in the door. A good thing of course.  But I realized some of that money was supposed to be set aside for the tax man.  I thought maybe I could hold off till the end of the year.  My reasoning was my wife has a W-2 job and has taxes taken out through her paycheck.  This statement provided some clarity on if this was true.

Individuals, including sole proprietors, partners, and S corporation shareholders, generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.

That’s helpful.  There is probably even some calculator out there that says if you make $XXXX you should file estimated tax payments.  I’m not looking for it, I just won’t.

Sticking with my IRS theme, apparently using the IRS 1040 ES form (with an snip-it of the document  shown below) is the answer to all of our questions.  Screw the calculator I’m a renaissance man! 

Self Employment Tax 1040 ES Form

Doing the Math with Self Employment Taxes

Here’s how I understand the self employment tax.  First I need to take my (Income minus Expenses).  I’m going to use numbers to make this a little easier. 

Let’s say for example I made $4,000 for the last 3 months.  Congratulations on the profitable quarter. Let’s also say I had $2,000 worth of expenses.  In this case the income minus expenses is very conveniently $10,000.

Income $12,000.00
Expenses $2,000.00
Profit $10,000.00

92.35% the Magic Number, The Tax Break

Now that I have my “profit” let’s look at what’s next.  The next step is to calculate my employer’s share aka self-employed me as a sole proprietorship FICA tax which is Social Security plus Medicare.  For 2019 this is 6.2% and 1.45% respectively for a total of 7.65%. Do you notice anything strange about this number?  

Yes it’s half of the 15.3% self employment tax.  Good work. This is also where I think things become more complicated but I’ll try to explain.  

Because what’s really interesting about all of this is you have to pay your share of the 7.65% but also your employer’s share, again also you.  The good news is you will not get taxed on the employer’s share. That’s why the 92.35%.

Right so we take our $10,000 profit and multiply it by 92.35% to get our total.   Since we made our math very simple our total is $9.235.

Social Security and Medicare Self Employment Tax

Alright now we have our $9,235 to work with.  It’s the next step to take the Net Income less our employer self employment tax and multiply it by Social Security and Medicare for a total of 15.3%.  

This looks like $9,235 multiplied by 15.3% for a total of $1,412.96.  I understand I’m a renaissance man with all this talk of not using calculators, but it’s always great to double check your numbers

If this sounds complicated, well I think it is as well.  Because I’m not talking about any self employed tax deductions, self directed 401Ks, or any of the the detailed understanding your CPA should have.  I’m just learning the self employment taxes game.  I will still have my CPA run through all of my taxes throughout the year and I’m sure he will correct me on some of what I have written and understand. 

Until then I hope this helps you and I understand self employment taxes just a little more. 

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