A few weeks back, we began our discussion on Choosing the Best Accounting Solution for a newly self-employed individual. Before moving forward, let’s go back to the basics and review what it means to be “SELF-EMPLOYED”.
So last year, you started working “on your own” which means you NO LONGER get paid a payroll paycheck through an employer. Instead, you are working different “gigs” as a “service provider” and get paid cash, check or direct deposit. What just happened…
A few VERY important things happened:
- You just became a Form 1099 Subcontractor
- You will be receiving a Form 1099MISC by January 31st of next year for NON-employee compensation paid to you by all “clients/payors”.
- You have been paid GROSS INCOME all year which means NO TAXES (aka income & SE Taxes) were withheld
- Sole Proprietor is another way of referring to a “Self-Employed” individual.
- You are required to file Schedule C with IRS Form 1040 to report income/loss for this activity.
- You are required to file Schedule SE with IRS Form 1040 to calculate self-employment taxes due to Schedule C income of $400 or more.
- You MAY have been required to pay quarterly estimated taxes this year if your business reported income from self-employed activity.
Ok, so that was a lot to take in, especially the self-employment TAX part, so let me break it down for you.
What does PAY Income & SE Taxes mean?
If YOU ARE self-employed, you must pay Income AND Self-Employment Taxes aka “SE taxes”. Income taxes are your federal & state income taxes that are withheld from your paycheck. You chose how much to “withhold in taxes” when you completed IRS Form W4. SE tax is Social Security and Medicare tax. You may have heard it referred to as “FICA” which stands for Federal Insurance Contributions Act.
SE Tax is calculated as follows:
Social Security Tax = 12.4% of “Adjusted” Net Profit
Medicare Tax = 2.9% of “Adjusted” Net Profit
“Adjusted” Net Profit = 92.35% of TOTAL Net Profit (Income-Expenses)
Therefore, SE Tax =15.3% OF 92.35% OF YOUR NET PROFIT
As an employee, ALL of these taxes have always been withheld from your paychecks by your employer. However, YOU were ONLY responsible to PAY the “employee portion” of FICA which is ½ of FICA tax 7.65% and YOUR employer would pay the matching 7.65% of tax.
So the TOTAL PAYROLL COST as an employee for an employer is Wages PLUS Employer Portion of FICA; in many case there are several additional payroll-related expenses that employers must pay for. A few of these are federal & state unemployment, workers’ compensation and employee benefits. We will leave that subject for another day…
NOW that you are Self-Employed, you are Your OWN Employer which means you need to pay BOTH sides of SE taxes (employee AND employer portions). And of course, your income taxes as well.
Not to worry, there’s an app for that! Check out my blog Deep Dive into QB Self-Employed and read the part on Quarterly Taxes Done Right.
Also, stay tuned for my upcoming blog related to this topic: Easy Options to Calculate Your Quarterly Self-Employment Taxes