Yes, in so many ways it is taxing and especially when you consider the self-employment tax. Just the name sounds wrong, “I am being taxed just because I am self-employed?” Kind of. Let’s take a look at this tax and understand exactly what it is.
When you are an employee, your employer withholds Social Security (FICA for us old-timers but officially OASDI – Old Age, Survivors, and Disability Income) from your paycheck at a rate of 6.2% of your taxable wages up to the limit. This is to pay for your social security benefit at retirement or your disability income benefit if you become disabled and have sufficient credits to qualify. This applies to income up to $118,500 in 2016 (no change from 2015.) That’s another reason to up your income above that $118,500 level!
They also withhold for Medicare at a rate of 1.45% on all income. There is no limit here and there can be a Medicare surtax on certain high income taxpayers.
If you have been an employee, you are used to seeing those amounts withheld as “payroll taxes.” Behind the scenes, your employer had to match those taxes and remit an equal amount as the employer contribution. When you are self-employed, guess who is the employer? You! You get the pleasure of paying the normal employee payroll taxes of 6.2% plus 1.45% AND the employer match of 6.2% and 1.45%. To make things confusing, the IRS just calls the total 15.3% self-employment tax.
When you complete the tax return, the software is programmed to consider the limit of $118,500 so it will apply the 15.3% to the first 118,500 and then just 2.9% to the amounts above that. If you have income of less than $400, you do not owe self-employment tax.
If you are self-employed, you will likely need to make estimated tax payments each quarter since there is no employer withholding these payroll tax amounts or the federal and state income tax amounts. You should make those payments by April 15th, June 15th, September 15th and January 15th to make sure you pay in most of your tax prior to the due date. If you underpay by more than $1,000, you may have to pay a penalty.
As you look at cash flow and consider how to increase income, don’t forget to plan for SE tax. However, as taxing as it can be to own your own business, the ability to create your own income stream, follow a passion, and build a business is like nothing else in the world!
To your financial (and business) success,