Mar
Self-Employment Tax 2019
Article By: Jeff Skolnick, CPA, M.S. Taxation
With the number of self-employed people growing each year I wanted to address self-employment tax. This is by far the biggest surprise that almost all encounter the first year that they are profitable.
WHAT IS SELF EMPLOYMENT TAX?
Self-employment tax is the way in which the government collects Social Security and Medicare taxes from self-employed people. The average person that works for a company is paid a salary. The employee’s paycheck is reduced by 6.2% for Social Security tax (also shown as FICA). This 6.2% is deducted until the employee’s wages exceed the Social Security limit ($132,900 in 2019). Also, the employee’s paycheck is reduced by 1.45% for Medicare tax. There is no wage limit on Medicare tax.
Example 1:
An employee receives a salary of $1,000 per week. The employee will see a deduction of $62.00 for FICA and $14.50 for Medicare taxes resulting in a net check of $923.50. This does not take in to account the federal and state withholding amounts or any other deduction such as state unemployment withholding.
In my example above, the employee has had a total of $76.50 withheld from his/her paycheck. The employer is required to make a matching contribution of $76.50, and thus the government collects $153 of Social Security and Medicare tax on the $1,000 salary.
Self-employed individuals do not receive a paycheck, and therefore the government needs another method of collecting Social Security and Medicare taxes. The method used is as follows:
A taxpayer calculates his/her net self-employment income by taking all allowable deductions against the gross income earned by the individual. The individual then pays both halves of the Social Security/Medicare tax. The calculation of self-employment is slightly different than Social Security and Medicare taxes for employees and the rate is approximately 14.1% on income up to the Social Security limit and approximately 2.7% on income above the Social Security threshold.
Example 2:
A sole proprietor has a net income of $1,000. According to the law, only 92.35% of self-employment income is subject to the tax. The self-employment tax is calculated by multiplying $1,000 by 92.35% and then by the 15.3%. The resulting self-employment tax is $141.30 (notice this figure is approximately 14.1% of $1,000).
Social Security and Medicare taxes levied against individuals and employers are never reduced by any deductions. Self-employment taxes are calculated based on net income of the associated business, and therefore a reduction in the net income not only produces an income tax savings but also serves to reduce self-employment tax.
Example 3:
A sole proprietor has a net income of $500. According to the law, only 92.35% of self-employment income is subject to the tax. The self-employment tax is calculated by multiplying $500 by 92.35% and then by the 15.3%. The resulting self-employment tax is $70.65.
Notice the reduction in self-employment income produced a reduction of self-employment tax.
Also there is no self-employment tax levied against self-employment income less than $400.
It is important to remember that this tax is separate from any other federal or state income taxes. It is, therefore, possible that a taxpayer has $0 income tax because of the standard or itemized deductions but still has a self-employment tax liability.
WHAT INCOME IS SUBJECT TO SELF EMPLOYMENT TAX?
- Any income earned by a sole proprietor or the owner of a single member LLC would be considered self-employment income.
- Income earned by general partners of partnerships.
- Income earned by members of LLCs if they perform services for their business or participate in management activities.
WHAT INCOME IS NOT SUBJECT TO SELF EMPLOYMENT TAX?
- Income from rental real estate
- Capital gains
- Dividend and interest income
HOW DO WAGES AFFECT SELF EMPLOYMENT TAXES?
Wages are subject to Social Security and Medicare taxes and therefore are not subject to self-employment taxes; however, if you earn both wages and self-employment income, then your wage income may reduce your self-employment liability. An example of this would be if you earned $140,000 of wages, then you have already surpassed the Social Security limit, and any self-employment income you have would be subject to only the Medicare tax, approximately 2.7% and not the full 14.1%.
HOW DO I PAY THE TAXES OWED ON SELF-EMPLOYMENT TAX?
Typically individuals with earnings that are not subject to withholding (such as income from a sole proprietorship, partnership or LLC) pay the government through quarterly estimated tax payments. The taxpayer will pay their taxes in 4 installments due April 15th, June 15th, September 15th and January 15th. The last payment occurs 15 days after the yearend.
CONCLUSION
This article gives only a basic overview of the self-employment tax. This area can be quite complex and can amount to significant dollars therefore I encourage consultation with a competent tax professional.
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