Content of the material
- Step #1: Make sure you actually have to pay
- How much is self-employment tax?
- Am I Required to File an Information Return?
- Here are some additional taxes for small business owners:
- What can I deduct from my side job or self-employment income?
- Tax deductions and tax credits
- How has coronavirus impacted the self-employed?
- Selling goods or services
- How Do I Make My Quarterly Payments?
- Understanding Self-Employment
- How to calculate your self-employment tax
- Step #4: Estimate how much you owe
- Calculating your freelance tax bill
- Advantages of Self Employment
- What Are the Main Types of Self-Employment?
- Summary: Becoming Self Employed
- 5 signs you’re ready to start a business
Step #1: Make sure you actually have to pay
Not everyone is subject to self-employment tax, but you’ll likely have to pay it if you are:
- A sole proprietor
- An independent contractor
- A freelancer
- A small business owner
- A gig worker
- A side hustler — even if you’re receiving W-2 income as well
Here’s the bottom line: self-employment taxes apply to all “earned income,” which is money received in exchange for a product or service. That’s true whether or not it’s your main source of income.
For instance, let’s say you work a standard 9-to-5 job, but sell your handmade jewelry on Etsy for a bit of extra cash. Your sales are subject to self-employment tax!
How much is self-employment tax?
Let’s take a moment to make sure we understand self-employment tax. If you work for yourself, it’s how you pay FICA taxes, which comprise Social Security and Medicare taxes. These are automatically withheld from W-2 employees’ paychecks.
Since freelancers and self-employed individuals don’t have employers, they get the special privilege of paying this themselves, for a whopping tax rate of 15.3%. Regrettably, this is added on top of your federal and state income taxes.
To learn more — including why this rate is so high — check out our guide to self-employment tax. In the meantime, how’s that smile holding up?
Am I Required to File an Information Return?
If you made or received a payment as a small business or self-employed (individual), you are most likely required to file an information return to the IRS.
Here are some additional taxes for small business owners:
- If your net profit is greater than $400, you must pay SE (Self-employment) taxes. Use Schedule SE, Self-Employment Tax, to calculate the taxes and report on Form 1040, Schedule 4, Other Taxes. The SE tax is a self-employed individual’s equivalent of the payroll taxes withheld by employers. If you are self-employed, you must pay your own Social Security and Medicare taxes and you will pay the equivalent of the employee and employer’s share, which is 12.4% for social security tax and 2.9% for Medicare taxes. Social Security taxes max out on wages and self-employment taxes of $132,900. You will still pay Medicare taxes on income greater than this but no social security taxes.
There is an additional Medicare tax of .9% for self-employed taxpayers who have a total earned income of more than $200,000 ($250,000 if married filing jointly or $125,000 if married filing separately).
What can I deduct from my side job or self-employment income?
There are many expenses you can deduct from your business:
- If you use your vehicle for business purposes, you may be able to deduct expenses associated with such use. You may choose the actual expense method or use the standard mileage rate. If you choose the actual expense method, you must also keep track of your vehicle-related expenses for the year. Vehicle-related expenses include gas, oil, insurance, repairs, cleaning, and registration. The business portion of your personal property taxes and vehicle loan interest is also deductible. Whichever method you choose, you must keep track of the mileage on your car from the first day of the year or the first day you use your car for business through the end of the year.
- Your employees’ wages and salaries are deductible if they are paid during the tax year for work directly related to your business and the pay is reasonable. You must be able to verify that the payments were made for duties actually performed. There are various types of withholding for different types of employees. Specific forms must be used for reporting payments made to employees.
- Advertising expenses including business cards, billboards, car wraps, ad agencies, etc. can all be deducted from your business income.
- Office supplies you purchase to operate your business.
- Rent paid for equipment, storage, or office space.
- Banking fees, credit card/debit card fees.
- Legal fees associated with your business.
- Professional fees such as bookkeeping, taxes, accounting, etc.
- Cleaning and maintenance. Maintenance includes little repairs, like having a plumber fix a leaky faucet.
- Membership dues paid such as Chamber of Commerce, local small business association, or trade group.
- Publications and books on the business or for the business – like magazines in a waiting room.
- And other expenses that are common for your business.
- Costs incurred when setting up an active trade or business, investigating the possibility of creating or acquiring a business, and some legal fees. You can choose to deduct up to $5,000 of business start-up costs now and claim a deduction of the remaining cost over 15 years. Franchise fees, goodwill, and customer-based intangibles are also amortizable.
- IRS regulations do not allow taxpayers to deduct the full cost of assets used in a business the year they are purchased, instead, they allow depreciation, which is a percentage of the asset to be deducted each year over a pre-determined “life” of the asset. There are some rules in place that allow for a greater upfront deduction, Special Bonus Depreciation, and Section 179 deduction.
You may recover your investment in certain business-related properties (such as equipment, a vehicle, or a building) through the use of depreciation.
Tax deductions and tax credits
When you’re looking for ways to save on your taxes, you might automatically jump to tax deductions and tax credits. But do you know the difference between the two? According to H&R Block, tax credits directly decrease the amount of taxes you owe, while tax deductions lower the overall amount of your taxable income.
Since deductions lower your taxable income, they also lower the amount of taxes you owe by decreasing your tax bracket, not by lowering your actual taxes. There are standard deductions and itemized deductions:
- Almost everyone qualifies for the standard tax deduction – the deduction amount varies based on your filing status (e.g., single, married filing jointly, married filing separately, or head of household), but everyone with the same filing status receives the same standard deduction amount.
- There are many possible itemized deductions, and the deduction amounts vary by individual. These are some of the most common itemized deductions:
- Certain medical and dental expenses above 7.5% of your adjusted gross income
- State income taxes
- State sales and local tax
- Property taxes
- Charitable contributions
- Mortgage interest
- Student loan interest
There is a catch when it comes to itemized deductions, however. Each taxpayer is only permitted to take either their standard or itemized deductions, whichever is higher, but not both.
When it comes to tax credits, there are two types – refundable or non-refundable:
- Nonrefundable tax credits allow you to reduce your tax liability to 0.
- Refundable tax credits can also reduce your tax reliability to 0. In addition, if there’s any amount left over from your refundable credit, you’ll receive the remaining credit balance.
Here’s an example of the difference between a tax credit and a tax deduction: If you’re in the 25% tax bracket, a $1,000 deduction lowers your taxes by $250. A $1,000 credit, however, lowers your tax bill by $1,000.
Which is better? If you had to choose, you’d probably prefer to receive a tax credit. Here is a list of possible tax credits:
- Earned income credit
- Additional child tax credit
- American opportunity credit
- Credit for federal tax on fuels
- Premium tax credit
- Health coverage tax credit
How has coronavirus impacted the self-employed?
While there are many advantages to self-employment the pandemic has thrown its drawbacks into stark relief. During lockdown those working for themselves didn’t have employee benefits, such as sick pay or the furlough scheme, to fall back on and freelancers began to loose opportunities and income as organisations set about cutting costs and terminating freelance contracts.
The Institute of Fiscal Studies highlighted sectors most directly affected by the pandemic and its restrictions:
- accommodation and food
- arts and leisure
- domestic services
- non-food and non-pharmaceutical retail
- passenger transport
- personal care.
Selling goods or services
You could be classed as a trader if you sell goods or services. If you’re trading, you’re self-employed.
You’re likely to be trading if you:
- sell regularly to make a profit
- make items to sell for profit
- sell items on a regular basis, either online, at car boot sales or through classified adverts
- earn commission from selling goods for other people
- are paid for a service you provide
If you only occasionally sell items or rent out property (for example through auction websites or short-term rental apps), check if you need to tell HMRC about this income.
Contact HMRC for advice if you’re not sure whether you’re trading.
How Do I Make My Quarterly Payments?
Estimated tax is the method used to pay Social Security and Medicare taxes and income tax, because you do not have an employer withholding these taxes for you. Form 1040-ES, Estimated Tax for IndividualsPDF, is used to figure these taxes. Form 1040-ES contains a worksheet that is similar to Form 1040 or 1040-SR. You will need your prior year’s annual tax return in order to fill out Form 1040-ES.
Use the worksheet found in Form 1040-ES, Estimated Tax for Individuals to find out if you are required to file quarterly estimated tax.
Form 1040-ES also contains blank vouchers you can use when you mail your estimated tax payments or you may make your payments using the Electronic Federal Tax Payment System (EFTPS). If this is your first year being self-employed, you will need to estimate the amount of income you expect to earn for the year. If you estimated your earnings too high, simply complete another Form 1040-ES worksheet to refigure your estimated tax for the next quarter. If you estimated your earnings too low, again complete another Form 1040-ES worksheet to recalculate your estimated taxes for the next quarter.
Although the precise definition of self-employment varies among the U.S. Bureau of Labor Statistics (BLS), the Internal Revenue Service (IRS), and private research firms, those who are self-employed include independent contractors, sole proprietors of businesses, and individuals engaged in partnerships.
A self-employed person refers to any person who earns their living from any independent pursuit of economic activity, as opposed to earning a living working for a company or another individual (an employer). A freelancer or an independent contractor who performs all of their work for a single client may still be a self-employed person.
A self-employed person is not often the same thing as being a business owner. The owner of a business, for instance, may hire employees and essentially become the boss—an employee-owner who operates and manages the business.
Alternatively, a business owner has an ownership stake but may not be involved in the day-to-day operations of the company. In contrast, a person who is self-employed both owns the business and is also the primary or sole operator. The taxation rules that apply to those who are self-employed differ from the employee or a business owner.
How to calculate your self-employment tax
The self-employment tax rate for 2019 is 15.3%, which encompasses the 12.4% Social Security tax and the 2.9% Medicare tax. Self-employment tax applies to your net earnings. For 2019, only the first $132,900 of your earnings is subject to Social Security tax (this amount increases to $137,700 in 2020), but a 0.9% additional Medicare tax may also apply to your self-employment earnings if they exceed $200,000 if you’re a single filer, or $250,000 if you’re filing jointly.
As mentioned earlier, to accurately calculate your self-employment tax, you need to calculate your net self-employment earnings for the year — which is your self-employment gross income minus your business expenses. Typically, 92.35% of your self-employment net earnings is subject to self-employment tax. Once you have your total net earnings from self-employment that are subject to tax, apply the 15.3% tax rate to determine your total self-employment tax.
If you’ve had a loss or just a little bit of income from self-employment for the year, there are two optional methods to calculate net earnings in the IRS Schedule SE.
Step #4: Estimate how much you owe
Now you just have to figure out how much to pay. If this is your first year going solo, be prepared for a much higher tax bill than normal thanks to that 15.3% self-employment tax.
Unfortunately, paying self-employment tax isn’t the only thing that makes tax season harder on freelancers. One of the silver linings of W-2 work is fewer surprises when it’s time to pay.
Income and FICA taxes are automatically withheld by the employer and remitted to the IRS at the time they’re accrued. Self-employed folks, on the other hand, have a harder time automating their tax bill.
Calculating your freelance tax bill
Remember that work I made you do in steps 2 and 3? Now you get to use it! To estimate your SE tax, you need to find your net income. This is your income after subtracting business expenses. For example, let’s say you earn $10,000 in gross income and have $5,000 in business expenses. Your net income would be $5,000. You’ll owe SE tax on this $5,000, not the full $10,000. So your SE tax would be $765 ($5,000 x 15.3%). If you’d like to use a shortcut here, Keeper Tax offers a free 1099 tax calculator that can do this calculation for you. Simply input your information:
And voila! An accurate estimate of what you’ll owe for your self-employment tax, federal income taxes, and state income taxes
Advantages of Self Employment
Why be self employed?
According to the study by Upwork and the Freelancers Union, most full-time freelancers prefer to be self employed because it allows them to have a more flexible lifestyle.
Additionally, the self employed want to:
- Be their own boss
- Work from the location of their choosing
- Choose the projects they work on
- Have a schedule that enables them to pursue their personal goals.
- Be in control of their financial future
- Have independence from factors such as office dynamics
- Be free to pursue work they’re passionate about or find meaningful
- Have the ability to pivot their skills and projects when it suits
- Spend more time with family
Self employment also opens up opportunities for individuals who would prefer not to work for a traditional employer due to personal circumstances, such as a disability, the need to take care of a loved one, or being a single parent.
But isn’t self employment insecure and unpredictable?
You can think of freelancing as volatile and risky, or as flexible and opportunity-rich,” said Sara Horowitz, author of The Freelancer’s Bible. “Doesn’t having multiple sources of income and multiple money-making skills sound less risky than putting all your eggs in one employer’s basket? Freelancing lets you shift gears when the world does.”
What Are the Main Types of Self-Employment?
The main types of self-employment categories are independent contractor, which is an individual working a specific job; a sole proprietorship, which is a business enterprise run by an individual and which may or may not have additional employees; and a partnership, which is a business structure between two or more individuals with ownership status.
Summary: Becoming Self Employed
Self employment is the process of earning money from your own endeavors, instead of being employed by someone else.
Self employed individuals go by different names, such as freelancers, independent contractors, and small business owners.
There are tons of advantages to self employment, too. Many people enjoy being self employed because they can be their own boss, have a flexible schedule, and work from home.
All in all, employment isn’t for everyone. If you’re one of these people, you might agree with businessman and speaker Farrah Gray, who said, “Build your own dreams, or someone else will hire you to build theirs.”
Start selling online now with ShopifyStart your free trial
5 signs you’re ready to start a business
There’s no ‘right time’ to go self-employed. You’ll develop skills and learn as you go along – but if you’d like some reassurance, you might be ready once you’ve:
- mastered a professional approach – When starting a business, you need the confidence and motivation to market yourself from day one. Many think that charging a reduced rate or offering to work for free is what’s required to build a client base, but remember that the work you’re doing will still add value to your client’s business or project and you should be compensated for this.
- found a unique selling point (USP) – One of the biggest misconceptions about self-employment is that to be successful a business must be started by an entrepreneur with a big idea. Having the right skills, passion and business acumen are more important factors for finding success.
- developed excellent organisation skills – Taking control of every aspect of your business is no mean feat. By creating a long-term business plan, or a weekly to-do list, you’ll have a clearer picture of where your business is heading.
- demonstrated resilience – Starting your own business doesn’t happen overnight and will require months – sometimes years – of hard work, and a thick skin. It’s a slow process, and you may encounter rejection from clients along the way, which can be disheartening.
- gained the confidence to build a client base – Building up a network contacts is crucial for establishing a client base – as daunting as it may seem. You’ll need the motivation, confidence and enthusiasm to be looking for potential opportunities at every turn when you’re starting out.