Self Employment Tax can come to a surprise for many first time business owners. Here is some helpful information for self employed individuals (SE). Unlike employees, self employed individuals are not withheld Social Security or Medicare (FICA) taxes along with pre-payments toward their federal or state income tax from their income during the year.
SE individuals are not being paid a wage; instead, they must keep their books showing income and expenses associated with their self-employed business allows them to determine their taxable profits or losses. Note; an employer and an employee each pay half the FICA taxes due on an employee’s wages and a self employed individual (SE) pays 100% of these taxes, termed the self employment tax, on his or her self employment profit. If the individual has more than one self-employment activity, the net profits and losses from the self-employment activities are combined to determine the SE tax.
Estimated Taxes: Since self-employed taxpayers don’t have taxes withheld on their self employment income, they need to pay estimated taxes quarterly based upon their taxable profits for the quarter and, after the first quarter of the year, taking into account prior quarterly profits and estimated taxes already paid for the year. These estimated taxes are paid with an IRS Form 1040-ES and include the taxpayer’s income and SE taxes.
Self Employment Tax: All self employed taxpayers who have more than $400 in net profit from their SE must pay self-employment tax, which is made up of Social Security tax of 12.4% on the first $132,900 (2019) of profit from the business and a 2.9% Medicare tax on all of the profits. In addition, there is an additional 0.9% Medicare tax to the extent the profits exceed $200,000 for single taxpayers, $250,000 for married taxpayers filing jointly, and $125,000 for married taxpayers filing separately. In addition, half of the self employment tax can be deducted from gross income. There are special rules for determining the self employment taxes for farmers and fishermen. If a self-employed taxpayer pre-pays less than 90% of his or her current year’s tax liability, including Social Security and Medicare taxes for the year, then the taxpayer can be subject to a penalty that assesses interest on underpayments by the quarter.
Estimated-Tax Safe Harbors – Instead of having to determine the quarterly profits and estimate the income tax and SE tax liabilities, some SE individuals instead choose to use the quarterly safe-harbor-payments method allowed by the IRS, which eliminates the underpayment penalty if correctly used. Note the two safe harbors available:
1. 100% of the prior year’s tax liability paid evenly for each quarter, provided the prior year’s adjusted gross income was $150,000 or less ($75,000 if using the filing status of married filing separate).
2. 110% of the prior year’s tax liability paid evenly for each quarter if the prior year’s adjusted gross income was greater than $150,000 ($75,000 if filing married filing separate).
The underpayment penalty does not apply if the final amount due on an individual’s tax return is less than $1,000. The penalty also does not apply if a taxpayer did not have a prior year tax liability for a full 12-month year. One thing to consider when deciding whether to use the safe harbor method is that because the safe harbor estimates are not based on the current year’s profits, a self employed individual could be in for an unexpected substantial tax liability at tax time.
Please contact Total Accounting for your tax needs or questions related to self employment tax. You can also call us for a free consultation at (727) 449-1835 or send us an email at CFO@mytotalaccounting.com.