Realities of Taxes for the Self-Employed
If you are self-employed, as many of our clients are, you know there are many advantages beyond just being your own boss. There are also unique challenges involved, especially how to handle taxes. Whether you’re running your own business or thinking about starting one, there are specific tax rules and opportunities that apply to you. Here is a look at the good and the bad.
The Self-Employment Tax
For those who work for an employer, payroll taxes to fund Social Security and Medicare are split between you and the employer. For the self-employed, you pay both halves – as employee and as employer. You pay this tax on all net earnings of $400 or more from self-employment.
The self-employment tax rate on net earnings (up to the Social Security threshold of $128,400 in 2018) is 15.3%, with 12.4% going to Social Security and 2.9% allotted to Medicare. Any amount over the threshold is generally subject only to the Medicare payroll tax. However, self-employment and wage income above $200,000 is generally subject to a 0.9% additional Medicare tax. (For married individuals filing jointly, the 0.9% additional tax applies to combined self-employment and wage income over $250,000. For married individuals filing separately, the threshold is $125,000.)
Self-employed people can file Form 1040 Schedule C, as either a sole proprietor, independent contractor, or statutory employee. The net income listed on Schedule C is considered “self-employment income” and must be included on Schedule SE, which is filed with your Form 1040. Schedule SE is used both to calculate self-employment tax and to report the amount of tax owed. You are allowed to deduct one-half of the self-employment tax paid (but not any portion of the Medicare surtax) when you compute the self-employment tax on Schedule SE.
Estimated Tax Payments
The self-employed need to make quarterly estimated tax payments (with IRS Form 1040-ES) to cover federal tax liability. You may have to make state estimated tax payments as well. Estimated tax payments are generally due each year on the 15th of April, June, September, and January. If you fail to make estimated tax payments on time, you may be subject to penalties, interest, and a large tax bill at the end of the tax year. So it’s important to stay on top of the quarterly payments.
If you are self-employed, you don’t have the option to contribute to an employer’s 401k or 457b plan to save for retirement. But you have other — sometimes much better — options. These plans also provide numerous tax benefits. A number of retirement plans are ideal for self-employed individuals:
- SEP IRA plan
- SIMPLE IRA plan
- Individual or Solo 401(k) plan
The type of retirement plan depends on your specific business cash flow and your circumstances and goals. In addition, if you have employees, your retirement benefits and maximums will hinge on their status.
Business Tax Deductions
With your own business, you can deduct some of the costs of starting that business, as well as all the current operating costs of running it. To be deductible, business expenses must be both ordinary (common and accepted in your field of business) and necessary (appropriate and helpful for your business).
Since business deductions will lower your taxable income, you should take advantage of all deductions that apply to you. You may be able to deduct a variety of business expenses, such as start-up costs, home office expenses, phone, and office equipment.
Healthcare Expenses and HSAs
If you qualify, you can benefit from the self-employed health insurance deduction, which enables you to deduct up to 100% of the cost of health insurance that you provide for yourself, your spouse, your dependents, and employees. In addition, if you are enrolled in a high-deductible health plan, you may be able to establish and contribute to a health savings account (HSA), which is a tax-advantaged account into which you can set aside funds to pay qualified medical expenses.
HSAs are the only savings vehicle that offers a triple play: tax deferral on contribution, tax-free growth, and tax-free withdrawals for qualifying healthcare payments. So don’t overlook these accounts if you have a high-deductible healthcare plan. But don’t go for the HSA if a high-deductible plan is not for you and your health. (Depending on your state, HSA contributions may or may not be subject to state taxes.)