Paying Self-Employment Taxes on a Quarterly & Yearly Basis - Tax Professionals Member Article By Dennis Jao
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Paying Self-Employment Taxes on a Quarterly & Yearly Basis

Paying Self-Employment Taxes on a Quarterly & Yearly Basis

You can't help but give Uncle Sam his due, and if you want to avoid an audit, it's important to get it right the first time. Unlike W-2 employees, the self-employed taxes are not automatically deducted from their payroll taxes. It's up to them to track what they owe and pay on time.

Since taxes are not levied automatically, the take-home pay of the self-employed tends to be higher than that of regular employees. However, if you don't want the IRS knocking on your door, setting aside some of those funds to cover your tax obligations is wise.


Entrepreneurs, whether self-employed, freelancers or business owners, are responsible for complying with tax laws with respect to their businesses. Financial literacy as a self-employed is a foundational skill, and that literacy includes understanding taxes.

As a self-employed, you have to keep some of your money back for taxes. You should pretend you don't have a lot of money because your income fluctuates so much. You have to think about paying taxes.

Tax forms are overwhelming, but learning the rules of taxation can be tricky. If you're filing a self-employed tax with the IRS, here are the basics for filing, paying, and saving for taxes.


What is the self-employment tax?

Social security and health insurance contributions are split between you and your employer when a company employs you. You pay just under 8% of your gross income for these taxes, and your employer matches this contribution.

You are subject to the full 15.3% tax when you do not have an employer. This tax is distributed as follows: 12.4% goes to social security and 2.9% to health insurance. You should note that only the first $137,700 earned in a year [this salary changes each year] has to pay Social Security tax. All salaries above are exempt. For Medicare, there is an inversion. Salaries above $200,000 per year are taxed at 3.8%, and there is no limit.


The basics of the self-employed tax return

Before defining your tax obligations, know your tax rate and determine if your region requires separate municipal taxes. To calculate the rate, first, calculate your business's net profit or a net loss. You can calculate it by subtracting business expenses from business income. If your income is more than your expenses, the difference is your net income and part of your income. If your income is less than your expenses, the difference is the net loss.

To prepare and file your taxes, you must first understand the state and local tax rates and taxes that may apply to you. To be able to determine your tax rate, you must first calculate your net profit or net loss for the tax period.

Therefore, if self-employment income exceeds $400, you must submit a Schedule C (Form 1040). Even if net self-employment income is less than $400, you still need to file a tax return if you meet any of the other conditions listed on Form 1040.

According to the Internal Revenue Service, self-employed taxpayers who expect to pay more than $1,000 in self-employment taxes must make estimated tax payments four times a year. You will need to use Form 1040 to file this quarterly fee.


How to calculate the tax for self-employed activities

The self-employed tax rate for 2021 is 15.3%, including the 12.4% Social Security tax and the 2.9% Medicare tax. Self-employment tax applies to your net income. For 2020, only the first $137,700 of your income is subject to Social Security tax, and this increased to $142,800 for 2021. Still, an additional 0.9% Medicare tax may apply to your self-employment earnings if it exceeds $200,000 if you file as a single taxpayer or $250,000 if you file a joint return.

As mentioned above, to accurately calculate self-employment tax, you need to calculate net self-employment income for the year, which is gross self-employment income minus business expenses. Typically, 92.35% of your net self-employment income is subject to self-employment tax. Once total net self-employment income is taxable, apply the 15.3% tax rate to determine total self-employment tax.

If you had a loss or only a small amount of self-employment income during the year, there are two optional methods for calculating net income in IRS Schedule SE.

How to file your taxes

Quarterly Payments

If you plan to make estimated quarterly tax payments, use Form 1040-ES, Estimated Personal Tax, which contains a worksheet similar to Form 1040. Keep your return as you will need the previous year's return to fill out Form 1040-ES.

You can use the blank vouchers included in Form 1040-ES to submit estimated tax payments, or you can pay online using the Electronic Tax Payment System (EFTPS). If this is your first year of self-employment, you'll need to estimate how much income you expect to earn during the year. 


Annual Payments

In order to file your annual return, you will need to report your income (or loss) from a business you carried on or a profession you practiced as a sole proprietorship. In order to report your Medicare and Social Security contributions, you must submit your Schedule SE (Form 1040), Self-Employment Tax.

Use the estimated income or loss on Schedule C or Schedule C-EZ to determine the amount of Social Security and Medicare taxes you have to pay during the year. The instructions in Schedule SE may be helpful when completing the form.


How to save on taxes

If you leave a full-time position for self-employment, you must identify write-offs. Here are some ways to write off taxes:

  • Health insurance premiums: If you are self-employed, you may be able to deduct health care costs for yourself and your family from tax.

  • Home Office Deduction: As a self-employed, you can deduct your home office if you keep a space dedicated exclusively to professional activities. To do this, you have to measure the square footage of your home office to determine how much you can deduct for rental or mortgage taxes, utilities, and property taxes.

  • Social Security and Medicare Taxes: Like other employers, self-employed individuals must pay full Social Security and Medicare taxes. However, you can write off half of it at the end of the year.

  • Start-up costs: If you recently started a new business, you can deduct start-up costs from your tax bill. This includes legal fees, marketing fees, and more.

  • Supplies and equipment: Office supplies or equipment you need to do your job may be tax-deductible.

  • Vehicle expenses: As a self-employed, you can deduct up to $25,000 of your vehicle expenses in addition to the specified mileage deduction for travel expenses.

You might be surprised what is tax-deductible. For example, advertising helps businesses make money, but it's also a big deduction for businesses, especially as self-employed.

A tax professional can help you identify write-offs that you can assess, simplify the filing process, and make it easier to identify your tax rate. 


Tax deductions and tax credits

When looking for ways to save on taxes, you can automatically jump to tax credits or deductions. But do you know the difference between credits and deductions? Tax credits directly reduce the amount of taxes owed, while tax deductions reduce the total amount of taxable income.

Because deductions reduce your taxable income, they also reduce the amount of tax you owe, lowering the tax rate without reducing actual taxes. There are standard deductions and itemized deductions:

Almost everyone is entitled to the standard deduction: the amount of the deduction varies according to their status (for example, single, married, separated, or head of household), but all people with the same tax status benefit from the same deduction lump sum. 

Many itemized deductions are possible, and the amount of deductions vary from individual to individual. 

However, there is a catch when it comes to itemized deductions. Each taxpayer can only make their own standard or itemized deductions, whichever is greater, but not both.

There are two types of tax credits: refundable or non-refundable:

  • Non-refundable tax credits allow you to reduce your tax to 0.

  • Refundable tax credits can reduce your tax credit to 0. In addition, if there is a residual amount of the refundable credit, you will receive the remaining credit balance.

Here's an example to help you differentiate between a tax deduction and a tax credit: If you fall into the 25% tax bracket, a $1,000 deduction reduces your tax by $250. However, a credit of $1,000 reduces the tax bill by $1,000.


Conclusion

Get ready for tax season. The key to preparing for your tax obligations is to track your expenses throughout the year. 


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Dennis Jao
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