To sign up for our daily email newsletter, CLICK HERE
Do you own a small business that isn’t a corporation or practice a profession that earns you more than $400 annually? Well, the IRS puts you in the self-employment taxpayers category. In addition to filing the annual income tax, you are supposed to file estimated taxes quarterly so that the IRS doesn’t impose a tax penalty for late or underpayment of the income tax. If you are facing trouble calculating the deductions or figuring out the income tax for the year, you should use the self-employed income tax calculator.
Just like the employee pays Social Security and Medicare taxes annually, the self-employed taxpayers are liable for the same, except they must manually file the tax returns. With tax withholding out of the picture, your only option to pay the tax is by calculating it manually. So, keeping track of all your business expenses during the financial year is important.
This will give you a clear picture of which expenses are to be deducted and where you are eligible for a refund. As a self-employed taxpayer, you can either pay the self-employment tax in a lump sum on April 15th (the final deadline for the tax payments in the States) or pay every quarter if your income from the self-employment sources is above $1,000.
Who Pays Self-employment Taxes?
Depending on your sources of income, you might be required to pay self-employment tax to meet your Social Security and Medicare obligations. You need to meet the below criteria to be considered self-employed.
- You are a sole proprietor or a partner in a limited liability company
- You are an independent contractor
- You take side gigs
- You are a part-time freelancer
If you have any source of income that isn’t a fixed salary paid by an employer, you will be considered self-employed and subject to a self-employment tax. Note that self-employment tax is not the typical income tax, which covers the federal and state tax.
As mentioned earlier, if you are self-employed, you pay both SECA and income tax. The latter has nothing to do with your employment status or the sources of your earnings. If your income for the calendar year exceeds the minimum threshold set forth by the IRS, you must pay income tax. Self-employed individuals, on the other hand, have to pay their share of Medicare and Social Security taxes.
Steps for Calculating Self-employment Tax
Having the knowledge of calculating the self-employment tax prepares you for the tax season. The following steps will give you an accurate idea of how to calculate the self-employment tax. If you are still facing any difficulty, you can consult a professional tax accountant to learn more about filing.
First thing first, you need to calculate your net earnings for the financial year. This can be achieved by subtracting your business expenses from the gross income.
Net Earnings for the year = Gross Income – Business Expenses
You can use the self-empoyed income tax calculator to figure out your net earnings. The Social Security and Medicare Tax rate applicable to your net income is 15.3%, but it’s only applied to 92.35% of your net income from self-employment sources. Basically, you have to multiply the tax rate (15.3%) by your net income.
Whether you are calculating your income tax manually or with the help of an accountant/software, just keep one rule in mind — the tax rate is 15.3% and is applicable to 92.35% of your income.
Subtract Deductions to Save More
The IRS allows a huge relief to the taxpayers who have to pay the income tax and self-employment taxes on their own. There is a set of deductions you can subtract from your net earnings in order to save more.
The biggest deduction is the one that cuts your self-employment taxes by half. Ideally, the employee pays only half of the income tax. But since you don’t have an employer who can pay the other half, the IRS allows self-employed taxpayers to reduce their taxable income by 50%. The social security tax is charged on the first $147,000 of your self-employment income. For the income exceeding this threshold, you only have to pay the 2.9% of the Medicare taxes.
There are several such deductions. Another example is home deductions. If you run a home business and have a small corner in your home dedicated to office use, you can deduct the amount equivalent to the expenses your business has incurred for the financial year. Here are a few other possible deductions you can subtract from your self-employment tax:
- Credit card interest
- Training and education expenses (only if they are relevant to your profession)
- Health insurance premiums
- Vehicle mileage
- Phone services and Wi-Fi bills
- Business income deductions (only those qualified by the IRS)
- Travel deductions
- Rent deduction
- Advertising and marketing cost deduction
- Startup expenses up to $5000 (only for the first year of starting a business)
- Retirement savings
- Club fees
These were only to name a few. For the complete list of deductions applied to your income tax, visit the IRS official website. You can also use an AI tax calculator to have all these expenses deducted automatically. Once you have linked your purchases to the AI tax calculator. It will suggest an allowed deduction based on your recent transactions. It asks you whether you’d like to accept or reject the suggestion. Then, it calculates your taxable income for the year and the total tax you owe the IRS.
How Do You Pay the Self-employment Tax?
Once you have calculated your net earnings and deducted the necessary items, the next step is to pay your taxes. This is the most crucial part. Any error or omission in your tax bill can result in penalties, especially if you are filing your taxes annually.
Most freelancer and independent contractors file their taxes quarterly so that they don’t feel a financial burden at the end of the year. These are called estimated tax payments. You estimate your income for the quarter based on your previous year’s tax bills and net earnings and apply a tax percentage to that amount. That can save you from the penalties and interest.
If you made very little profit for the year or experienced a loss, you can use Schedule SE (Form 1040) to report that. You can be a freelancer and a permanent employee at someone’s firm. If you are an employee and a self-employed individual, you can add both to determine your total Social Security and Medicare taxes obligations. First, you have to pay taxes from your employed income (which is automatically withheld from your salary). If you owe additional tax to the IRS, you can calculate that from your net earnings from the self-employment income.
Overpaid and Underpaid Taxes
Remember, tax is not automatically deducted from your self-employment income (unless you have a source that withholds your income). So, you need to calculate it manually and fill out the estimated tax payment forms every quarter to ensure that all your dues are cleared by the end of the year.
Not only does it avoid penalties on late payments, but it provides financial relief when the tax season arrives. Estimated tax payments are important for those reporting a net earning of more than $1,000 from self-employment sources.
Now that you are calculating the tax on the estimated income, it’s obvious that you will make mistakes in the calculation. You never know whether you will make a profit or loss for the financial year. Besides, there’s no fixed salary for self-emploiyed individuals. So, there’s a good chance you can overestimate or underestimate your tax. Overpaid tax is never a problem, as you can request the IRS to issue you a full refund. Underpayment is allowed only if you are filing the tax returns for the first time and you did the guesswork for estimating your income.
To avoid underpayment penalties, you should use the self-employment income tax calculator to get a clear picture of your net earnings for the year and the taxable amount. The tool comes in handy when you are taking itemized deductions. Just remember the due dates for estimated tax payments. As the income isn’t withheld automatically, you have to download the estimated tax forms from the IRS website, fill them out on your own, and send it to the IRS.
Self-employed taxpayers must understand their tax obligations and file their income tax returns in compliance with the latest tax laws. We have already mentioned the steps for calculating your taxable income, but if you are still facing any difficulty doing your taxes or submitting them to the IRS, feel free to seek help. There are many tax professionals and accountants who specialize in income tax and self-employment tax filing. You can ask them about the deductions, the right way to file tax returns, and more. Or, you can use a self-employed income tax calculator to simplify the calculation part. Hope it helps.