It is often the case that workers who have just started out on their own business, gone freelance or changed to contracting ignore some of the less exciting, more boring differences that come with the self-employment way of working. In addition to a fresh perspective and thrill about your own career and a new control of your career direction and possible increased financial rewards, there are equally a number of downsides to consider and financial or taxation hurdles to account for before heading out on your own.
One of those hurdles is Self-Employment Tax. As an employee working for a company you were never made to pay Self-Employment Tax but had to pay it under a different name. Self-Employment Tax is the FICA (Federal Insurance Contributions Act) tax for the self-employed that is used to pay for medicare and social security and which comes out of your self-employment net earnings. As a company employee chances are you never thought about the FICA payment, mainly because your employer paid half of it for you, roughly 7.65% each. Once you are classified as self-employed however, whether you are an independent contractor or a sole proprietor, you must pay the total 15.3% tax yourself. Once you earn over $433 per year, you qualify to pay the 15.3% charge. And if your earnings go over $106,800 you then pay 2.9% for each dollar thereafter.
How can you be sure if you’re required to pay it then? In a nutshell if you think you’re self employed in any way, then you need to pay the SE tax and it will be levied on your net business earnings. If you usually file a Schedule F, a Schedule C (profit and loss from a business) or a Schedule E with partnership income then you must fill out a Schedule SE and make a payment for the SE tax. It is worth bearing in mind though that this relates to income coming from your self-employed work and earnings and not from any kind of investments – investment income isn’t subject to the SE tax. Dividends, interest, royalties and rents as well as capital gains are accordingly not taxed under the SE tax.
After that you need to realize that when you were employed by a company your employer would have handled the payment of this tax. Now you have to make sure it is done. Moving to the contracting sector inevitably means more responsibility and more paperwork. You’ll have to calculate your own Self-Employment tax using Schedule SE and add this figure to the ‘Other Taxes’ section of your 1040. This lets the IRS differentiate between the SE tax and income tax. You’ll also be required to estimate your tax obligation quarterly in January, April, June and September and your estimates need to be close – if they aren’t enough or if you don’t pay then you could face interest charges and penalties.
There are, nevertheless, many ways to reduce your Self – Employment tax burden and it is worth chatting with your accountant to find out more.
About the Author:
Alex Simmonds is a freelance journalist and copywriter living in the UK. He can currently be found writing a blog on contracting and home-working for The Bedouin Group.
