Self Employment Tax in the United States
Self employment tax story time…
“Holy cow! That can not be right! I usually only owe a few hundred, not six grand!”
My buddy stared at the tax return I’d just help him prepare shock аnd hоrrоr.
Не hаd lоst hіs јоb іn thе rесеssіоn, but hаd bееn аblе tо рісk uр wоrk аs аn іndереndеnt contractor.
Although he worked exclusively with one company, they’d chosen to keep him off the official payroll.
He had diligently saved up some cash for his tax bill, but had used the previous year’s return as a guide, back when he was still a regular worker.
I showed him the Schedule SE, “Bro, this is what’s hitting you hard, self-employment tax, which is Medicare and Social Security payments. Back when you were an employee, your employer was responsible for half, and you’re responsible for the other half, roughly 7.65% of your wages each. It was deducted from your salary and you probably never really thought about it, except to look at your check stub and cry about high taxes every now and again…”
He looked miserable at his return, “Man, I knew that I was going to be responsible for my tax payments and that I wouldn’t get any benefits, but I had no idea the taxes were going to be this high. I didn’t factor that into the wage back when I first got the contract job; I was just pleased to be working in any way.”
I shook my head in sympathy and answered, “You know, about every year I get a lient in this same scenario. They get hit with a tax bill that’s significantly larger than what they had expected, and they’re not sure why. I wish you’d come to me back when you started out as self employed; we would have done some planning, which might have reduced or even eliminated this bill…”
What Is Self Employment Tax?
Self employment tax is the percentage of earnings that you need to pass on to the tax authorities (the government’s rules, not ours).
The higher your income, the higher the tax you will need to pay. Sounds simple, right?
There are also ways that you can reduce your tax liability and you will receive some benefits (in general and up to a point).
Want more information? Then check out the IRS website.
Who Must Pay It?
The tax for self employment is imposed on net earnings from your business. If you are reporting your business income on a Schedule C, then it will be the bottom line of the return.
If you file a Schedule C (Profit or Loss From Business), a Schedule F (Farming), or a Schedule E with income from a partnership then you will have to file Schedule SE and, if уоu hаvе mоrе thаn a certain level of tоtаl іnсоmе frоm аll thе аbоvе sоurсеs thеn уоu wіll nееd tо рау sеlf еmрlоуmеnt tах.
Who Doesn’t Have to Pay It?
Self employment tax is on earned income from your labor, and so investment income isn’t subject to self employment tax.
Notably, income from a Subchapter S corporation (S Corp) is also excluded because they are investment income. Many business entities could easily qualify to be organized as either a partnership or an S Corp, and so the chance to prevent self employment taxation has been a factor that has made the S Corp very attractive as an entity.
The Way to Minimize or Prevent It
Thinking back to the type of income that’s subject to self employment tax – If you want to reduce or avoid the tax consequences, you want to have a valid reason.
The generally acceptable way is to claim back the expenses you are entitled to take.
For example your company rental or lettings charges.
If you would like to learn more about taxes and being self employed start a conversation on the Live Chat now and a member of our team will be happy to assist you. Or complete the form below for a free callback today.
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