One of the best parts of being self-employed is seeing the full glory of your efforts – known as your gross receipts – hit your bank account, sans tax. Even though Uncle Sam lets you slide up front, you must be diligent in preparing for tax season as a self-employed entrepreneur.
Generally, you are obligated to pay self-employment taxes if you earned $400 or more in net income from self-employment. You could be working for yourself or for someone else who issues you a Form 1099 as a nonemployee. If that describes your work arrangement, you are probably a sole proprietor, a partner in a partnership, or an owner in an LLC.
Be prepared because you probably owe some self-employment taxes. We’ve collected our top tax tips for solo business owners so you know what to expect.
Tip #1 – Your Self-Employment Taxes Explained
When you work for someone else, your federal employment taxes are handled by someone else. Each pay period, your employer pays their portion – an amount equaling 7.65% of your gross income that period – of Social Security and Medicare taxes (FICA) and deducts your portion – also 7.65% – from your paycheck. Your employer sends those taxes to the federal government.
But when you are self-employed, you don’t have an employer to share the cost or send in the tax. You are responsible for paying the full 15.3% employment tax. Here’s the breakdown of what that amount consists of and the caps on each amount based on your earnings:
- 12.4% goes to Social Security. These funds go to providing benefits for the disabled, elderly, and their qualifying family members. For 2022, the first $147,000 of your yearly net income is subject to this tax, but all amounts above that are exempt.
Note: that cap amount changes each year, so pay attention if your self-employment income approaches that level.
- 2.9% goes to Medicare. This tax covers the hospital insurance programs which provide medical benefits to the elderly and citizens suffering from specific maladies. For 2022, all of the wages you earn up to $200,000 are taxed at 2.9%.
Be aware that if you earned net self-employed income over $200,000 as a single filer or $250,000 and file jointly, you will also be subject to an additional Medicare tax of 0.9% on wages earned above those limits.
Tip #2 – How to Calculate Your Self-Employment Taxes
This can be a little tricky, so we’ve broken this into 5 basic steps:
- Start by adding up your revenues for the year. You can get this information from your accountant if you don’t have the data already.
- Add up all of your business expenses. These are all the costs you incurred to run your business. The federal government lets you deduct these expenses from your income when calculating what tax amount you owe.
- Your net income will equal your total revenues for the year minus your total expenses.
- Generally, only 92.35% of your net income is subject to the federal self-employment tax. Multiply your net income by that percentage.
- Finally, multiply the remaining portion of your net income from Step #4 by the 15.3% tax rate to get your total taxes owed.
To illustrate, here is a quick example of calculating self-employment taxes.
- Stella earned $50,000 in income as a self-employed business owner in 2022.
- She incurred $10,000 in business expenses, bringing her total net income to $40,000.
- Multiplying her net income by 0.9235 brings her to her total income subject to the self-employment tax: $36,940.
- Multiplying that income by 0.1530 tells her that she will owe $5,651.82 in self-employment tax for 2022.
Tip #3 – How & When To Pay Your Self-Employment Taxes
When you’re self-employed, you must remit your own employment tax payments. Because taxes are collected by the U.S. federal government on an ongoing basis, you need to be making estimated quarterly payments on your taxes in order to avoid underpayment penalties.
To find the amount you should be paying each quarter, you can use one of two methods:
- The yearly estimate method. Estimate the amount of income you expect to make this year and use that figure to calculate your estimated self-employment taxes (the calculation in Tip #2). Then split that tax into four even payments.
Note: This is the best method if you have a pretty regular income.
- The annualization method. Use the income you’ve already earned this year to figure out what to pay. This method annualizes your tax at the end of each quarter based on a reasonable estimate of your income and expenses from that year so far. This one is a bit tricky to figure out on your own, so we highly recommend using the IRS Worksheet 2-7 to help you calculate it.
Note: This method is best for entrepreneurs with fluctuating or unpredictable incomes throughout the year.
Each quarter, you’ll fill out and file Form 1040-ES to show your estimated tax. You can submit your payment by mail, online, or using the IRS’s many apps and tools.
At the end of the year when it’s time to file your annual taxes, you’ll need to fill out and file Schedule C to report your self-employment activity.
If you couldn’t tell from this math-heavy article, handling your taxes as a self-employed entrepreneur can be tough. With the annual tax season right around the corner, let us know if you need any help with your self-employment tax calculations.