Is Self-Employment Tax Keeping You Stressed?

Self-Employment Tax Got You Stressed? Learn Exactly What It Is and How to Pay Less

Self-employment tax can feel like a burden, especially for those new to the world of freelancing or running their own businesses. But as the proverb says, "The wise man builds his house upon the rock." [Matthew 7:24-27] A solid understanding of this tax is your financial foundation. This blog post will guide you through the ins and outs of self-employment tax, empowering you to manage it effectively and potentially reduce what you owe. Is Self-Employment Tax Keeping You Stressed? Understanding it thoroughly can help you take control and ease your financial worries.

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Resources for Self-Employed Individuals

Before we dive in, here are some helpful resources to bookmark:

• IRS Website: The IRS website is a treasure trove of information for self-employed individuals, including publications, forms, and online tools¹.
• MyFreeTaxes: This program offers free tax preparation services, including assistance for self-employed individuals².
• NYC Financial Empowerment Centers: These centers provide free financial counseling and coaching, which can be beneficial for freelancers and other self-employed individuals³.

What is Self-Employment Tax?

Self-employment tax is how those who work for themselves pay into Medicare and Social Security. It's similar to the taxes withheld from the paychecks of traditional employees, except that you're responsible for both the employee and employer portions⁴. This is because when you're self-employed, you wear two hats – you're both the employer and the employee in the eyes of the IRS⁵.

This tax is made up of two parts: ⁶

• Social Security:4% on the first $168,600 of your combined wages, tips, and net earnings from self-employment in 2024. This threshold is subject to change annually.
• Medicare:9% on all of your combined wages, tips, and net earnings from self-employment.

This brings the total self-employment tax rate to 15.3%⁷. It's important to note that the self-employment tax only applies to 92.35% of your net earnings. This allowance is designed to put self-employed individuals on a level playing field with traditional employees⁸.

Important Note for High Earners: If your combined wages, compensation, or self-employment income (along with your spouse's income if filing jointly) exceeds a certain threshold, you'll be responsible for an additional 0.9% Medicare tax⁶. These thresholds are:

Who Needs to Pay Self-Employment Tax?

If you're earning income through self-employment, it's likely you'll need to pay this tax. Specifically, the IRS requires you to pay self-employment tax and file Schedule SE (Form 1040 or 1040-SR) if either of the following applies: ⁹

• Your net earnings from self-employment (excluding church employee income) were $400 or more.
• You had church employee income of $108.28 or more.

This applies to a wide range of self-employed individuals, including: ¹⁰

• Sole proprietors
• Independent contractors
• Partners in a partnership
• Members of a limited liability company (LLC)
• Freelancers

It's important to note that these rules apply regardless of your age or whether you're already receiving Social Security or Medicare benefits⁶.

Be Prepared for a Potential Surprise: Many individuals transitioning from traditional employment to self-employment are often surprised by the amount of taxes they owe at the end of the year⁸. This is because, as an employee, your employer withheld taxes from your paycheck. As a self-employed individual, you're responsible for calculating and paying these taxes yourself.

How to Calculate and Pay Self-Employment Tax

Calculating your self-employment tax involves a few steps:

1. Determine your net earnings: This is your gross income from your business minus allowable business deductions and depreciation¹¹.
2. Calculate your self-employment tax: Multiply your net earnings by 92.35% and then by the 15.3% tax rate⁸. You can use Schedule SE (Form 1040 or 1040-SR) to figure this out⁶.
3. Make estimated tax payments: Since you don't have an employer withholding taxes from your income, the IRS requires self-employed individuals to make estimated tax payments on their income and self-employment tax throughout the year, typically on a quarterly basis⁶. You can use Form 1040-ES to calculate and pay these taxes¹². It's crucial to make these payments on time to avoid penalties and interest⁴.

How to Make Your Payments:

• Direct Pay: Pay directly from your bank account through the IRS website or by phone¹³.
• Check or money order: You can mail a check or money order with your Form 1040-ES¹³.
• Debit/credit card or digital wallet: You can pay through third-party providers, but processing fees may apply¹³.

Obtaining an ITIN: If you don't have a Social Security number, you'll need to obtain an Individual Taxpayer Identification Number (ITIN) from the IRS to pay your self-employment tax. You can apply for an ITIN by filing Form W-7⁶.

Filing Your Taxes: When it's time to file your annual tax return, you have two options: ¹³

• E-filing: This is generally the most convenient and secure method. You can use tax software or hire a tax professional to e-file your return.
• Paper filing: You can also download the forms from the IRS website and mail them in.

Self-Employment and Social Security Benefits

Paying self-employment tax isn't just about fulfilling your current tax obligations; it also impacts your future Social Security benefits. The amount you receive in Social Security benefits is based on your earnings history, including your self-employment income¹¹. To be eligible for these benefits, you need to have worked and paid Social Security taxes for a certain length of time, typically 10 years¹¹.

Tips to Reduce Self-Employment Tax Liability

While self-employment tax is unavoidable for those who work for themselves, there are legitimate ways to potentially reduce your liability:

• Deduct the Employer-Equivalent Portion: You can deduct the employer-equivalent portion of your self-employment tax (7.65%) when calculating your adjusted gross income¹⁰. This deduction reduces your income tax, but not your self-employment tax liability¹⁰.
• Deduct Half of Your Self-Employment Tax: You can deduct half of your self-employment tax as an adjustment to income on Form 1040⁷. This further reduces your income tax liability.
• Maximize Business Expense Deductions: Thoroughly preparing Schedule C to deduct every possible business expense is crucial¹⁴. The more deductible business expenses you have, the lower your net earnings will be, and therefore, the lower your self-employment tax¹⁵. Keep accurate records of all your expenses, such as office supplies, travel, and home office deductions¹⁶.
• Consider an S Corporation: Forming an S Corporation can potentially reduce your self-employment tax liability¹⁷. With an S Corp, you pay yourself a reasonable salary, which is subject to self-employment tax. However, any profits above your salary can be taken as dividends, which are not subject to self-employment tax¹⁷. This strategy can result in significant tax savings.
• Contribute to a Retirement Plan: Contributing to a retirement plan, such as a SEP IRA or a solo 401(k), can reduce your taxable income and help you save for the future⁴.
• Deduct Health Insurance Premiums: If you're not covered by an employer plan, you may be able to deduct your health insurance premiums¹⁸.
• Claim the Earned Income Tax Credit (EITC): If you meet the eligibility criteria, you can claim the Earned Income Tax Credit, which can reduce your tax liability or even result in a refund⁶.

Christian Perspective on Self-Employment Tax

As Christians, we are called to be good stewards of the resources God has entrusted to us. This includes managing our finances responsibly, and that extends to our taxes. Proverbs 27:23-24 reminds us to "Be sure you know the condition of your flocks, give careful attention to your herds; for riches do not endure forever, and a crown is not secure for all generations." Just as a shepherd diligently cares for their flock, we must diligently manage our financial affairs, including understanding and planning for our tax obligations.

While taxes may seem like a burden, they also contribute to the well-being of society. Romans 13:6-7 instructs us to "pay taxes, for they are God's ministers, who are constantly attending to this very thing. Pay to all what is due them—taxes to whom taxes are due, revenue to whom revenue is due, respect to whom respect is due, honor to whom honor is due." By paying our taxes, we contribute to the common good and support the services that benefit our communities.

Conclusion

Self-employment tax can be complex, but by understanding the basics and utilizing available resources, you can manage it effectively and potentially reduce your tax liability. Remember to keep thorough records, explore potential deductions, and consider seeking professional advice from a tax advisor to optimize your tax strategy.

As Christians, we are called to be good stewards of our resources, and that includes managing our taxes responsibly. By taking proactive steps to understand and plan for self-employment tax, you can alleviate stress and focus on what you do best – running your business or pursuing your freelance career with the peace of mind that comes from knowing you're fulfilling your financial obligations in a God-honoring way.

Works cited

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