What Are Self-Employment (SE) Taxes?
For the sake of argument, let’s say you’re an employee. Since 1990, 7.65% of your paycheck has been sucked into the government’s coffers before you even saw it. Your employer has been doing the exact same amount in tandem by paying 7.65% of your paycheck to the government in payroll taxes for each of their employees.
By now you’ve probably done the math: 15.3% of every employee’s paycheck goes to the government right away (up to the annual Social Security cap at least, which in 2019 is $132,900). If you want to get technical, the 15.3% is split into 12.4% towards Social Security and 2.9% towards Medicare. Note that those who earn more than $200,000 in a year ($250k for married filing jointly) will owe an additional 0.9% Medicare tax.
Once you start considering self-employment, you, unfortunately, get some bad news from the get-go: if you are your own boss, then you become responsible for paying both the employee and the employer payroll taxes.
Wait, You Mean My Payroll Tax Doubles?
In a word, yes. The government cares not whether you work for yourself or for a different employer: they want their 15.3% and they will get their 15.3%!
Unfortunately, there’s even more bad news. Many employees can get away with just focusing on their work and not bothering to look at their paychecks at all. They can just review their W-2 once a year at tax time (we, of course, recommend that you review every paycheck). As a self-employed person, now you have to both pay more taxes and pay more attention.
How to Schedule Your SE Tax Payments
Estimated taxes, filed using form 1040-ES, are due four times a year: April 15th, June 15th, September 15th, and, finally, January 15th of the following year. That’s right: “four times a year” should not be confused with “quarterly” because these reports are not due quarterly; they’re due at odd months. Update your calendar.
Calculating and Paying SE Taxes
You know when and how frequently estimated tax payments are due, but how do you figure out how much you owe?
The process of estimating your tax due is not simple, because it involves projecting your revenues and expenses forward through the year, adjusting for seasonality and business or personal tax events. Thankfully the IRS has (semi) rock-solid rules that, if followed, will guarantee that you don’t owe any penalties. (You’ll still owe any underpaid tax of course — there’s no avoiding that.)
Here are the rules:
- If, after all is said and done, you owe less than $1,000 in taxes (that is, tax due less taxes paid, regardless of how high those numbers are) then you’re golden. No penalties, but still be sure to send any payments owed along with your tax return.
- The rock solid rule: If your total estimated payments are at least 90% of the total tax of the previous year, then the IRS pinky-swears it will not charge you penalties or interest on any underpaid taxes. Again, you still have to pay the underpaid taxes.
- If you pay at least 100% of what eventually becomes your tax due (110% if your AGI is over $150k), then you will owe no penalties or interest on underpaid taxes. This rule is harder to follow than rule 2 because no one knows what the future holds!
If you’re shooting for options 1 or 3, then it would behoove you to have an accountant go over your financials in order to provide you an accurate estimate. The IRS often charges a percentage of underpaid taxes as a penalty, which means your accountant could pay for themselves in avoided penalties.
Once you have your estimated tax calculated, you can pay the IRS directly. You’re done for now; just make sure to keep track of the weird due dates and avoid late payments.
The Good News
If all this bad news leaves you wondering why you’d ever want to work for yourself, just keep in mind that you will most likely be able to take more and larger deductions on your taxes, such as business expenses. Being able to deduct business expenses, along with limited liability, are two of the biggest reasons people work for themselves.