The term ‘self-employed’ describes a person who, or an entity that, is a business owner. As such, ‘self-employed’ may refer to a sole proprietor, an LLC, or even a partnership. When it comes to the payment of self employment tax, a small business must develop a strategy aimed at paying less.
This strategy generally involves making decrements to profits earned by indicating legitimate deductions to the same; the rule here is that the more the deductions, the lesser the business taxes will be. There are two types of taxes that must be paid by the business owner: income tax and self-employment tax.
1Definition of Self Employment
Any of the following describe the characteristics that define a self-employed person:
- You are engaged in a business or trade as an independent contractor or as a sole proprietor.
- You are an associate in a partnership that engages in a trade or business.
- You do business for yourself.
You don’t have to conduct a business or trade on a full-time basis to be self-employed; people who have and run their own business in addition to holding regular jobs, i.e., part-time businesses, can also be considered self-employed.
Independent contractors are those people who engage in an independent trade that offers service to the general public, e.g., doctors, lawyers, accountants, auctioneers, etc. The facts in each case determine whether such people are employees or independent contractors but the latter term applies if someone paying for a service only reserves the right to control the result of the work and not what or how it will be done. Independent contractors’ earnings are subjected to self employment tax. Employees, on the other hand, have employers who have the legal mandate to control and direct every aspect of their (the employees) job regardless of the degree of freedom accorded to them.
2For Whom are Self Employment Tax Payments Mandatory?
The payment of self employment tax and filing of Schedule SE (Form 1040) is mandatory if either of these conditions applies:
- Your self-employment net earnings (excluding income as a church employee) are $400 or more.
- Your income as a church employee was $108.28 or more.
It is only after earnings from self employment have been subjected to self employment tax that one’s net earnings from the trade or business can be established. Self employment tax rules are applicable regardless of age – they apply even for persons who are already on social security retirement benefits or Medicare.
3Self Employment Tax for a Part-Time Business Owner
As indicated earlier, part-time business owners are also required to pay self employment taxes based on the net earnings from their businesses; they are personally responsible for remitting these. The amounts they earn as employees are mandatorily subjected to deductions for social security/Medicare taxes. It is the employer who makes these deductions and remits the sum to the IRS.
4Definition of Self Employment Tax
Self employment tax is the deduction from earnings that goes towards self-employed people’s social security and Medicare tax; this is akin to the social security and Medicare tax levied on employed people’s wages. While employers are responsible for figuring out what their employees will pay in taxes, self-employed people do this on their own with the help of Schedule SE (Form 1040). In figuring out their adjusted gross income, self-employed people can deduct half of their self employment tax. It is not possible for employed persons to deduct their social security and Medicare taxes.
5Self Employment Tax Terminology
- Self employment tax rate – The rate stands at 15.3% and is composed of 12.4% in social security and 2.9% in Medicare.
- Maximum earnings subject to self employment tax – It is only the initial $106,800 of one’s combined tips, wages and net earnings for 2009 that is subjected to any grouping of the 12.4% portion of self employment tax, social security tax, or railroad retirement tax. On the other hand, the entire amount of your earnings for 2009 are subjected to any grouping of the 2.9% Medicare portion of self employment tax, social security tax, or railroad retirement tax.
- Fiscal year filer – While using a tax year different from the calendar year, it is mandatory to apply the maximum earnings limit and tax rate in effect at the start of that tax year. Even if these two variables change in the course of your tax year you must keep to the initial limit and rate.
- Self employment tax deduction – To figure out your gross adjusted income you may deduct half the self employment tax but the deduction will only affect your income tax and not your net earnings or self employment tax.
6Paying Self Employment Tax
Before you can pay self employment tax you must be in possession of either a SSN, i.e., social security number or an ITIN, i.e., individual taxpayer identification number.
To obtain a social security number, if you have never had one before, you may make an application using Form SS-5, Application for a Social Security Card. This form is available at any Social Security office and the telephone contact to use is (800) 772-1213. Alternatively you may download the form here.
As for the individual taxpayer identification number, you can be issued one by the IRS in case you are an alien (resident or non-resident) and you don’t have or don’t qualify for an SSN. The form to fill out for the ITIN is Form W-7, Application for IRS Individual Taxpayer Identification Number.
You pay self employment tax using estimated tax. These taxes are paid during the year as you earn or get income, given that federal income tax is pay-as-you-go by nature. If you anticipate owing tax, self employment tax included, of $1000 or more upon filing your return, you normally have to remit estimated tax payments. Estimated tax payments are mandatory if you are self-employed and don’t have income tax withheld.
