Sole Proprietor or Partnership? Don’t Forget Self-Employment Taxes
If you operate a business as a sole proprietor or in a partnership, you’ll need to set aside additional income (and time) to satisfy your self-employment (SE) tax obligations. SE taxes are added to your income tax, but there are deductions that only the self-employed can utilize, and these deductions can reduce your income taxes and overall tax burden.
Of course, nothing is easy when it comes to taxes, so there’s plenty of additional paperwork to fill out to report your SE taxes. It’s easy to get lost in all of it, especially for busy business owners who don’t have the time to manage their taxes. Fortunately, a tax planning and preparation expert can manage them for you and your business, so there are no surprises come tax season.
Why Do the Self-Employed Pay Additional Taxes?
First, if you are on this list, you likely need to pay self-employment taxes:
- A sole proprietor
- A general partner in a partnership
- An independent contractor or freelancer
- Someone working a W-2 job and 1099 simultaneously
Income that is not generated for profit (as a hobby, in other words) is exempt from SE taxes, as is real estate rental income.
SE taxes are required because they serve as a replacement for payroll taxes that W-2 employees must pay. Many people are unaware of the payroll taxes that come out of their checks every couple of weeks. These taxes are provisioned for Social Security and Medicare, and they add up to 7.65 percent for W-2 employees. The employer withholds these taxes following every pay period, as they are technically due as soon as employees are paid.
The self-employed obviously don’t have an employer, so they are responsible for both halves – all 15.3 percent – of Social Security’s and Medicare’s cut. The Social Security portion is 12.4 percent, and the Medicare portion is 2.9 percent.
The Social Security portion of SE taxes does not apply to any self-employment earnings over $147,000. The Medicare taxes are much stickier and do not phase out at higher incomes. In fact, there’s an additional 0.9 percent Medicare tax for income in excess of $200,000 (single filers) or $250,000 (married, filing jointly).
How to Calculate Self-Employment Taxes
Calculating SE taxes is relatively simple. The worst part may be seeing how much you owe. To determine that, follow these steps:
- Calculate your self-employment income. Ideally, you’ll have 1099 records to pull this information from. Any organization or person that pays you for services (in excess of $600) should send you one. If you don’t receive the 1099s that you should, contact the payer and request one. However, it’s quite common for the self-employed to go without one or more 1099s that they’re owed.
That’s why we strongly recommend you maintain your own income records and not rely on a 1099 to keep track. You can still report your income and pay taxes on it even without an official 1099 to go by.
- Multiply your self-employment income by 92.35 percent (or .9235). Self-employed taxpayers are allowed to deduct half of their SE taxes from their self-employment income. That’s the same amount as the employer portion of SE taxes, so you’re like your own boss in this regard.
- Take that adjusted number and multiply it by 15.3 percent (.153). This is what you’ll owe in SE taxes.
However, the math isn’t done there. As a self-employed taxpayer, you are allowed to deduct half of your SE taxes from your taxable income for income tax purposes. This can make a modest dent in your income taxes.
What Additional Tax Deductions are Available for the Self-Employed?
We’ve already mentioned a couple of deductions that SE taxpayer can use to reduce their income tax burdens. However, there are plenty more, and this is where the complexity sets in for the self-employed. For example, some of the most common deductions relevant to the self-employed include:
- Home Office Deduction – If you use a part of your home as an office, solely for work purposes, then you may be eligible for the Home Office Deduction. Under this deduction, the self-employed are allowed to deduct a portion of their rent (or mortgage), utilities, mortgage insurance, homeowner’s insurance, and repairs. The deductible portion is equal to the amount of space your office space occupies in your home. So, for example, if your office takes up 10 percent of your home’s square footage, you can deduct 10 percent of rent, utilities and so on.
- Startup Costs Deduction – Business owners are allowed to deduct up to $5,000 of their startup costs during the first year of operation. There are several expenses that qualify under this deduction, including attorney, accountant, and advertising fees. Many capital expenses also apply.
- Internet and Phone Bill Deductions – If any of your internet or phone-related expenses are purely for business purposes, they can be deducted from your SE taxes. This may include the cost of running a business website, or the cost of a second phone line for business calls.
- Health Insurance Premiums Deduction – If you pay for your own health insurance and do not qualify for a plan through your spouse’s employer, then you may be eligible for the Health Insurance Premiums Deduction. Through this deduction, the self-employed may deduct their health and dental premiums from their SE taxes, as well as any premiums used to provide coverage to family members and dependents.
There are many more that could go on this list, and your tax professional can identify which deductions you’re eligible for, and how they can be optimized for your situation.
Confused About Self-Employment Taxes? An Experienced Tax Planner Can Provide Guidance
Taxes are complicated enough for W-2 employees, but the self-employed have to deal with an additional layer of complexity. For many business owners and independent contractors, there aren’t enough hours in the day to keep up with self-employment taxes (or any tax-related activities, for that matter).
If this applies to you, an experienced tax preparation and planning professional can help. With a tax expert on your side, you’ll get the peace of mind that comes with total tax compliance, along with the peace of mind that comes with not having to do your taxes on your own.
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