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

Ralph00:00:00

Are you self employed and feeling the weight of self employment tax? Imagine waking up every day with that heavy burden on your shoulders, worrying about whether you're doing everything right. It's a struggle that affects not just your finances, but your work, your family, and even your faith. But what if I told you there's a way to lighten the load? Well today, we're diving deep into the world of self employment tax. We're going to break down what it is, how it works, and most importantly, practical steps to reduce what you owe. So get comfortable, and let's tackle this together.

Podcast Announcer00:00:32

In a world where crushing debt keeps you trapped, where living paycheck to paycheck has become your new normal, and where the dream of retirement seems impossibly out of reach, there's hope. Join financial evangelist Ralph Estep Jr. A man who's walked through the fire of financial failure and emerged stronger on the other side. Welcome to Ask Ralph, the show where real world experience meets biblical truth to break the bondage of financial despair. Get ready to take control of your money, break free from the financial stress and align your resources with God's purpose for your life. This is Ask Ralph with Ralph Estep Jr.

Ralph00:01:09

Welcome everyone. I am Ralph, your Financial Evangelist. And today, we're helping Dwight, he's a freelance writer, understand and reduce self employment tax. So let's make this journey together and find financial peace of mind. Now, if you missed yesterday's show, we discussed common tax filing errors. Hey, we don't want to make those. And if you missed it, you can check it out at askralph.com. And today, it's all about self employment tax. So, as I said, we got this letter from Dwight. He's a freelance writer and he needs help. And this is what he wrote. He said this. "Dear Ralph, I've been freelancing for about a year and a half now. I'm really struggling with self employment tax. It's keeping me up at night, and I'm constantly stressed about it. I feel like I'm drowning in paperwork. I'm terrified that I'm not doing everything right. It's affecting my work, it's affecting my family, and it's really affecting my faith. I desperately need help understanding what self employment tax is, and more importantly, how to reduce what I owe. Please, can you guide me through this?" Well Dwight, I just want to start by thanking you for reaching out and I can feel your pain. I've seen many clients struggle with this Dwight, and I'll share the story of Jim, the contractor a little bit later because he was in a very similar situation to you and we worked together and we found a solution. So Dwight, let me tell you, there is hope. And today, we're going to tackle this together. Now, before we get started, I want to remind you to submit your questions. So just like Dwight did, you go to justaskralph.com because the truth is I love answering your questions because it's the central part of the show. Well, as we always do, let's turn to the Bible for guidance today. Dwight, I found this in the book of Psalms chapter 46 verses 1 to 3, and it says this. "God is our refuge and strength, an ever-present help in trouble. Therefore we will not fear, though the earth gives way. And the mountains fall into the heart of the sea." Well, let me just tell you, I've used that verse many times, not just in today's show, but in general. Because it reminds us to be prepared and to have a strong foundation. And if you listen to my show, you know I say it all the time. It all starts with a strong foundation. Well today, I want to start with some gratitude and I am grateful that God has given me the experience to help people just like you, Dwight. So thank you for your question and the opportunity to share this important topic. Alright, Dwight, let's dive into self employment tax. Let's understand what it is and how to reduce what you owe. So imagine you're hiking up a beautiful mountain. That's your freelance journey. You're carrying a backpack, it's filled with your dreams, it's filled with your goals, and it's filled with your tools. But then all of a sudden you notice there's an extra load. And in our discussion today, that extra load, that's self employment tax. It's like a heavy rock that's in your bag. And see, self employment tax is how freelancers, just like you Dwight, pay into Medicare and Social Security, and it can feel overwhelming. It can feel stressful. But don't worry. We're going to lighten that load together, but let's start by understanding just what is self employment tax. And it's really made up of two parts. There's Social Security and there's Medicare. I'm going to get a little bit into the weeds, but then we're going to talk bigger picture here in a few minutes. So for 2024, the social security tax rate, ready for this, is 12.4%. And that applies on the first $168,600 of combined wages, tips, and earnings that you're making. So basically, you're going to pay 12.4% social security tax on the first $168,600 of your earnings. Now the Medicare tax, that's an additional 2.9%. And it applies to all of your wages. There's no cap on that. So if you think about it, Dwight, that total self employed tax rate is 15.3%. Now I'm gonna get into weeds for a second, but just remember that only applies to 92.35% of your net earnings. But here's the deal. It's an additional 15.3% in addition to your federal tax. And if you live in a state with state tax, add that to the top and you're getting close to 40, maybe 45%. So let's talk about who needs to pay self employment tax. This is a thing that a lot of people don't understand. So if you're earning income through, guess what? Self employment. It's why we call it self employment tax. Then you're most likely going to need to pay this tax. And it requires that you pay it if you have net earnings from self employment of $400 or more. Now I'm just going to set a little side if we've got any church workers here, they actually set that number at $108.28. I have no idea where they came up with that one. But basically if you make $400 a year or more, and what we call self employment, then you've got to be paying this tax. Now let's talk about how to calculate and pay the tax. I'm going to dive into the numbers for just a couple of minutes. I don't want to lose anybody because stick with me because I'm going to get to some big picture things here in a few minutes. Let's talk about some real life examples. Let's talk about Emily. Now Emily's a freelance writer and Emily earned $50,000 in what we call net earnings last year. So that is not her gross earnings. That was her net after she put in all of her expenses. You know, she's a freelance writer. Maybe she had some office expenses. Maybe she had some travel expenses. You get the idea. So her net income was $50,000. So to calculate her self employment tax, she multiplies that $50,000 in earnings times that first threshold. That's at 92.35%. So that means her actual earnings subject to social security and Medicare tax are $46,175. And it becomes really simple. She simply multiplies this amount by that 15.3% tax rate, and ready for this. This is an additional $7,068.75. So in addition to her federal tax, in addition to her, if she lives in a state that has state income tax, she owes a whopping $7,068.75 in addition to those other taxes. But you need to understand how to calculate that because that's so important. But then once you calculate it, I want to just land for a second and let's talk about how you pay it because calculating it is part of the deal, paying it is another part of the deal. So we talked about this a few minutes ago. We're going to talk about your net earnings. That's your gross income. That's what came in the door minus your allowable business expenses. That could be things like computer equipment, could be mileage, it could be depreciation. So you calculate that total net earnings and you multiply it as we talked about. Now, the IRS wants you to pay this, not at the end of the year, not when you file your tax return by April 15th, but as you go. So that's why, because if you think about it, you don't have an employer that's withholding that. When you work for somebody else, you get that net paycheck, and that's what you can live on. Well, the IRS requires that you make estimated tax payments. Now I'm not going to get lost in the details. You can go check out my other shows that talk about it, but it's really crucial that you make these payments on time to avoid penalties and interest. Because what a lot of people don't know about it and a lot of times, it happens in the first year that they do this side gig, or they have this online business. Then all of a sudden they realize they owe money and then the IRS is charging them penalties way back because they should have been making tax deposits as they went. So now we understand the basics. Let's get into the most important part. The most important part you're talking about Dwight is how can you reduce that self employment tax liability, right? That's what you're really concerned about. So let's explore some practical steps that what you can do Dwight and remember, our goal is we talked about at the beginning, you're on that hike, you're doing that freelance writing. Our goal is to lighten that backpack. Well, for the first things you can do is you can deduct what's called the employer-equivalent portion. So you can deduct the employer equivalent portion of your self-employment tax. So let me explain this in simple terms. When you work for somebody else, you only pay the employee share. So you basically pay half. Your employer is paying the other half. So that means that 7.65% can be used to reduce your adjusted gross income because this deduction reduces your income tax. Now it doesn't reduce the self employment tax, but it reduces the income tax. So that's the first thing you want to make sure that you're doing. I would highly recommend you work with a professional in this, but if you're doing your own taxes, that's the first thing. The second thing is you can deduct half of that self employment tax. So you can deduct half of that self employment tax as an adjustment to your income. That's on the 1040 form if you file that as a personal tax return. And what this does is this further reduces your income tax liability. So that's the things you want to take off and understand. Now, that's the deductions. But there are more strategies to consider. So, are you ready for more, Dwight? All right, let's get to them. Number three, you can maximize your business expense deductions. As we talked about with Emily, we started off with that gross number. Maybe that's what she collected in total revenue. Maybe she's running an online store. Maybe she's doing some side gigs, that sort of thing. So what you want to do, depending upon what kind of tax return you have, you want to thoroughly go through and look for every single deduction, because here's the deal. Big takeaway. The more deductible business expenses you have, the lower that net earnings will be. And if the lower the net earnings will be, the lower the self employment tax. It's not complicated. So one of the things I'm going to recommend that you do is keep accurate records of all of your expenses. I was working with a client yesterday and we were getting to this point where I was saying to him. Listen, what did you spend on internet this year? What did you spend on travel? What did you spend on office expenses? All of those things, because the goal is to try to get that number, that net earnings from self employment down as low as possible, because that's going to do a couple of things. Number one, it's going to reduce your self employment tax and it's going to reduce your overall income tax. Now, one of the things that you can do, and you got to be careful with this one is you can consider using a portion of your home and take what's called the home office deduction. But here's the thing. And I've talked about this on the show before. You got to make sure, that you are using it exclusively for business purposes so you can deduct a portion of your rent. You can deduct a portion of your mortgage, a portion of utilities and other expenses related to the space. Now I'm not going to spend a lot of time talking about, but make sure it's regularly and exclusively used for business. This isn't an extra bedroom where somebody sleeps at night, but you're doing business here during the day. You've got to be really careful with this because this is one of the key things that the IRS looks at. And see, that's why I'm saying, maximizing deductions is crucial. It is really the best place to go, but there's another even more powerful strategy. And Dwight, we're going to talk about this next. And I'm going to ask you a simple question, Dwight, have you considered forming an S corporation? So let's get right to that. And here's why I'm going to talk about that. Forming an S corporation could potentially reduce your self employment tax liability immensely. I use this with clients all the time. See with an S corp, you can pay yourself a reasonable salary. Now the IRS doesn't define what reasonable is. That's where you want to work with somebody like me to understand that. Now, why would you do that? Because then what you're basically doing is you're carving your income into two pieces. Piece number one is that reasonable salary. On that reasonable salary, you're going to pay social security tax. You're going to pay Medicare tax. And since you're paying it for your own business, you're going to pay both sides of that, both the employee and the employer portion, but here's the benefit to this strategy. Any profits that are over and above that salary are basically taken as dividends. Dividends are not subject to self employment tax. So let's use a simple example. Let's say that your net business profit before you take a salary is $100,000. That's what, that's what the net would be. So if you weren't taking a salary, if you weren't set up as an S corporation, you'd basically pay $15,300 worth of self employment tax. Simple math, $100,000 x 15.3%. $15,300. Well, what if you did this. What if you took half of that, took $50,000 of that in salary. Now on that $50,000, you're still going to pay the social security and Medicare, but here's the beautiful part. On that other $50,000, you're going to save 15.3%. If I'm doing my math, that's a little less than $8,000. So this tip today, if you do this and I can help you set this up, will save you potentially $8,000 on $100,000 profit. So let's talk about Jim. I talked about Jim at the beginning of the show. That was the contractor I mentioned earlier. Now, Jim came to me. He was a lot like you, Dwight. He was overwhelmed by this self employment tax. He had no clue how to reduce it. He didn't understand why he had to pay it. And he was, I looked at his tax return. This dude was paying a ton in tax. It was causing him all kinds of stress. He felt like he was drowning in paperwork. But that was the turning point because he was, and Dwight, let me ask you this. Are you curious to know what it was Dwight? Well, here's the turning point. The turning point for Jim is when he came to me, he had seen an ad for me or listened to the podcast show. And he said, Ralph, I had heard some ideas about how you can reduce this. So we sat down and we talked about this S corporation strategy. And I explained to him how forming this S corp could potentially reduce his self employment tax liability. So with that S Corp, Jim could pay himself, like we talked about a few minutes ago, a reasonable salary. I can't tell you until I sit down with you individually and understand the nuances of your business. But when he did that, any profits over and above that salary will be taken as dividends. And that particular strategy could save you thousands of dollars. And it did for Jim. It saved him thousands of dollars in self employment tax. Because it's all about lightening the load. So Jim decided to give it a try and the results were amazing. By forming this S corporation, Jim was able to save thousands of dollars in self employment tax and it was like a heavy weight had been lifted from his shoulders. And the most beautiful part of that. He finally had the financial breathing room he needed to grow his business and to provide for his family. But guess what? Dwight, it didn't stop there for Jim. With the money he saved on taxes, Jim took my advice and he was able to start funding a retirement plan for himself. He started contributing to what's called a SEP IRA, and I'm not going to go into those today, but that is a beautiful thing because this not only helped him save for the future, but again, this was a tax deduction. It reduced his taxable income in the tax year. So we were able to cut way back on the self employment tax. We were able to fund the SEP which further reduced his taxable income. Now, Jim also was able to use a portion of his tax savings to reinvest in his business. He purchased new equipment. He expanded his services and that allowed Jim to grow his business. It allowed him to take more and more clients and ultimately increase his revenue. Contributing to a retirement plan is another smart move. So Dwight, are you thinking about your future? You might want to consider that at all as well. So let's talk about that because contributing to a retirement plan can reduce your taxable income. If you reduce your taxable income, that's going to help reduce your taxes and it's going to help you save for the future. Think about it like this. I think this is a great analogy. Think of it like planting a seed today. You go out into the garden, you plant that seed, you make sure that the dirt is all fixed up around, you put some water on it and that seed could grow into a mighty oak tree in just a little bit of time. That's how a retirement plan works. Now, health insurance is another area where you can find savings. Have you considered deducting your health insurance premiums, Dwight? That's something else that you can deduct to help reduce your taxable income. So let's talk about that. If you're not covered by an employer plan, if you don't have the traditional plan, because like you said, you're working for yourself, you're self employed, you may be able to deduct your health insurance premiums. That's like getting a discount on your healthcare membership. And that is really what we're talking about today. Now, I know we've covered a lot today, so don't forget, I do write a daily blog post based on the content of the show where I go even deeper. I share some specific resources and some great valuable tools. You'll find all of that, all of our blog posts at askralphpodcast.com/blog. Well, now let's take a moment to reflect on what we've discussed today, Dwight, because we have handled a lot. It felt like a lightning round. Number one thing. Here you go, Dwight. What is one action step that you can take today to reduce your self employment tax liability? Just find one. We talked about several. What is one that you can take? Are you going to consider setting up that S corporation? Are you going to think about really looking at your expenses? Are you going to think about funding that retirement? Are you going to deduct your health insurance costs and get that health, a healthcare discount? So just find one. Second question. How can understanding self employment tax help you build a stronger financial foundation and grow in your faith? See, knowledge is power Dwight. And what I've shared with you today, a lot of people don't know about, they march into their tax preparer's office and they just pay and they pay and they pay because they don't understand some of the strategies that I've talked about today. And number three. In what ways can you then apply that wisdom that we got from Psalm 46 to your financial situation? I always like to bring it back to the Bible, bring it back to the word of God and make it profitable for you. So Dwight, I'm going to encourage you to do all of those things today because you can save thousands and you can give yourself a better retirement and more importantly, give yourself peace of mind today. Now, if you found value in today's show, or if you're finding value in the show, in general, I want to encourage you to consider supporting the show. I, and really, I really want you to think about this. By doing that, by helping us, you're helping us reach more people with this message of hope. You're helping us help people like Dwight who are looking for ways to find that financial peace of mind, are looking for ways to save money on their taxes. Now you can get to our support page, it's real simple. Just go to askralphpodcast.com/support and your support, whether it be a one time support or an ongoing support will allow us to help someone who may be facing the very same issues that we're discussing today. It could be a game changer. So why don't you consider partnering with us? You also can share the show with others who will benefit from the issues that we've covered. You can simply say, Hey, I know this guy, he's got a great show. You can get it on audio. You can get it on a video. Just send them to askralph.com. Because remember this. It's our obligation as Christians to reach out to others and help them. That is what we're supposed to do. All right, Dwight. Well, let's get back to my key takeaways from today's show. So number one thing, self employment tax is like that heavy rock in your backpack. We talked about the self employment tax rate is 15.3% and you only pay that on 92% of your income. Well, guess what? 92% still a lot. So it's a big deal and it's on your net earnings. So one of the things we talked about ways to reduce your self employment tax liability. We talked about deducting the employer equivalent portion. We talked about maximizing business expense deductions. We talked a little bit about the S corporation. We talked about contributing to a retirement plan. And finally, we talked about health insurance premiums. And here's my big takeaway, Dwight. If you can practice these practical steps, you can lighten that backpack and you can reduce your self employment tax burden and you can find that financial peace of mind that you're looking for and more importantly than that, you can grow in your faith. So Dwight or anyone else listening, if you're feeling overwhelmed by self employment tax, I want you to know that you don't have to walk this path alone. We talked about you're on that hike. Well, guess what? I can come along and help you. I'm here to help you find success. I'm here to help you find peace in dealing with this financial issue. So let's work together. Let's create an individualized plan tailored to your unique situation. You can book a call with me by simply going to askralph.com and click on the button that says book a call with Ralph. And remember, you've got to take the first step. I can't do it for you. So do it today and let's get to that financial peace of mind. So before we wrap up today, I just want to share a few quick letters from listeners who have been helped by the show. And this one comes from Barry and Barry writes this. He says, "Dear Ralph, thank you so much for your show. I've been struggling with my finances for years, but your practical advice and faith based approach have given me the hope and the tools I need to turn things around. I'm finally starting to see the light at the end of the tunnel. Thank you for being a beacon of hope." Well Barry, I appreciate the feedback. It helps me keep going. You can tell I'm energetic today because I want to help people save money. I want to help people find that financial peace and Barry, it's great to hear that it's working. Now Tina sent this in. She said, "Ralph, your show has been a lifesaver for me. I was drowning in debt and didn't know where to turn. Your advice has helped me create a plan to pay off my debt and start saving for the future. I can't thank you enough for your guidance and support." Well Tina, I can't thank you enough for being a loyal listener, and I'm just going to encourage you, Tina, share the show with other people so that they can feel those same successes that you're sharing. And I got this one. I love this guy's name. His name is Buck and I'm just picturing this burly guy. And this what Buck said. He said, "Hi Ralph, I just wanted to let you know that your episode on budgeting changed my life. I was living paycheck to paycheck, but now I have a budget that works for me, and I'm even able to save a little bit each month. Keep up the great work." Well Buck, you keep up the great work because you're the one doing it. You're the one that's breaking free of that bondage of living paycheck to paycheck. You're living on that budget. And I am so happy for you now that you're starting to save a little bit each month, that is fantastic. Now, before we wrap up, I also want to share a success story with you. I want to inspire you, Dwight and anyone else. Listen, let's talk about Laura. Now, Laura was a freelance designer and she was also struggling with self employment tax. She was stressed, she was overwhelmed, and she, again, like a lot of people say, she's drowning in paperwork, trying to figure this out. But after listening to the show, she implemented the strategies we discussed and Laura was able to do this. Let me just tell you, she was able to maximize her business expense deductions, saving her thousands of dollars in self employment tax. Laura did like the other persons have done. She formed that S corporation, it allowed her to pay herself that reasonable salary and take the rest of her profits as dividends. And guess what else she did? She contributed to that SEP IRA, and that helped her save for the future and reduced her current year taxable income. And let me just tell you, 'cause this isn't the first time I've talked about this on the show. Laura now is thriving. Her business is growing and she's no longer stressed about those self employment tax. She's found what we're all looking for. Dwight and everyone else listening. She's found that financial peace of mind and is able to, and listen to this, the best part. She's able to focus on her passion. Her passion is designing beautiful websites for her clients. And now that she doesn't have the distractions of that self employment tax and trying to figure all this out, she can really focus on her passion. Now tomorrow we're going to be discussing another interesting tax topic, and that's how your rental property affects your taxes. If you're a landlord or you're thinking about becoming one, you don't want to miss the episode tomorrow. Now, we're going to be covering topics tomorrow, like the tax advantages of owning rental property. We're going to talk about depreciation. What do you need to do to calculate that. And we're going to have a big discussion. A lot of people don't understand this about rental properties that's why I got this question in. It's like the perfect time to talk about it. We're going to talk about the difference between active and passive income, but bigger than that, why it matters. So join me again tomorrow. It's going to be a great topic. So as we wrap up, let me leave you with this thought. So just as God is our refuge and our strength in times of trouble, understanding and managing our financial obligations, just like self employment tax can truly bring us peace and it can bring us stability. Just imagine for a moment the relief you feel when you've taken the first step towards reducing your tax burden. Picture that freedom. You have to focus on your work and your family, knowing that you're handling your finances wisely. So Dwight, what's the first step you're going to take today? Will you start by maximizing your business expense deductions, or perhaps you're going to get in touch with me and you're going to set up that S corporation, whatever it is. Remember this Dwight and everyone else listening. Every small step counts and if you need help along the way, again, I'm here to help you. You got this Dwight, you're not alone in the journey and with God's guidance and the practical steps we discussed today, you can overcome the burden of self employment tax. So Dwight, keep moving forward one step at a time. So thank you for listening and I'll look forward to seeing you tomorrow and until then, as I always end the show, stay financially savvy, stay strong in your faith, and remember that with God, all things are possible. So goodbye for now and have a great day.

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