Deciding to go it alone and become self-employed can be a rewarding experience, but it can also be very overwhelming, especially when dealing with taxes. “Where do I start?” is usually the first question people ask on their self-employed journey. That’s where we’re going to begin with this Self-Employed Beginner’s Tax Guide.
Employee vs. Self-Employed
As a self-employed individual, you will pay the same taxes as people who are employees: Federal Income Tax, Social Security and Medicare. The difference, however, is that the responsibility is now on you as the self-employed person.
As an employee, your employer collects your Federal Income Tax, Social Security and Medicare by withholding it from your gross pay. You just have to collect your paycheck and rest easy that your taxes have already been withheld. It’s quick and painless.
As a self-employed individual, however, you have to actually do the work to plan for your taxes and remit them to the government. With every dollar that comes in or leaves the business, you have to think of taxes and having enough cash to pay your tax bill. This is a much harder situation for self-employed individuals to get used to since it’s much different than being an employee.
Federal Income Taxes
As a self-employed individual, you will pay federal income taxes on the net income of your business. Net income is just the money left over after your business pays for all of its bills and expenses. However, the way you will pay taxes depends on your business structure.
If your business structure is a pass-through entity like sole proprietors, LLCs, partnerships and S corporations, then you’re business will not pay tax at the business level (at least in most cases). The profits of the business are passed down to the owners, who pay taxes at the personal level.
So, if you own 50% of a business that had net income of $100,000, then you would pay taxes on $50,000. All of this would be on your personal return.
Self-Employment Taxes
1. Social Security
As an employee, you pay in 6.2% in Social Security on income up to $132,900 (wage base) from your paychecks, and your employer pays in an additional 6.2%.
As a self-employed individual though, you will pay in all 12.4% in Social Security up to the same wage base.
Wait a minute. How is this fair?
Well, as a self-employed individual, you can take a deduction for that extra 6.2% that you had to pay in when you file your tax return. So, it’s basically the same thing with a bit of a timing difference.
2. Medicare
Employees pay in 1.45% of their wages in Medicare with their employers paying an additional 1.45%. When you’re self-employed, you will pay in all 2.9%, but once again, you can take a deduction for half of the amount paid when you file your taxes.
How do I make tax payments?
Well, as an employee, your employer is responsible for withholding these taxes and remitting them to the government. That is no longer the case once you’re self-employed.
Self-employed individuals must make estimated tax payments on a quarterly basis to pay in their taxes due. Usually, this is done using estimates based on the prior year and paid in four equal payments throughout the year (April, June, September & January).
However, if your business is new, then you may want to base your payments off of your actual net income in each quarter.
Either way, you need to make sure you make these payments because the government can impose penalties if you wait until your tax filing to pay in full.
Why do they care?
It’s a pay-as-you-go system and the government wants to make sure they get their share before you lose the ability to pay. Anything can happen as the year progresses, and if you’re not planning for taxes, it’s a heavy burden to deal with all at once.
Just be sure to pay in 100% of your tax due from last year (110% for high income earners) or 90% of your expected tax due for this year to avoid penalties.
How do I pay?
You can pay estimated taxes in a variety of ways including by credit card, check, electronic funds withdrawal or through the EFTPS system. I find the EFTPS system to be the easiest by far, but it’s really up to you.
You can download the EFTPS Enrollment Instructions below to help you get set up to use the EFTPS system.
Download EFTPS Enrollment Instructions here
Other Taxes
When you’re self-employed, there are also some other taxes that you may incur if you have employees. Paying Federal Unemployment (FUTA), State Unemployment (SUTA) and Workers Compensation in addition to Social Security and Medicare on your employees all must be taken into account.
These extra taxes are what you think of when others say that you pay more as a self-employed business owner. That’s true in one way. If you think about it though, paying more in taxes due to having employees can be a win-win. If the employees provide you with significant value and opportunities, then it’s probably worth it.
These taxes are detailed in our blog post on Types of Payroll Taxes that you can find here.
Wrapping it Up
Your taxes due as a self-employed individual are very similar, if not identical, to those due from employees. The methods used to pay your taxes are a little bit different, but overall, it’s essentially the same. Just be sure to consider your taxes when deciding what to do with the cash in your business. That is by far the most important piece of the self-employed taxes puzzle.
For more information on self-employed taxes, visit the IRS’ Self-Employed Individuals Tax Center.
Note: This blog post is meant for educational and informational purposes only. Please contact a tax or accounting professional if you have specific questions before taking any further action. Also note that this list may not be exhaustive depending on your business situation.
