What Is the Self-Employment Tax?

Working for yourself, either as a part-time side hustle or a full-time endeavor, can be very exciting and financially rewarding. But one downside to self-employment is that you're responsible for following special tax rules. Missing tax deadlines or paying the wrong amount can lead to expensive penalties.

Let's talk about what the self-employment or SE tax is and how it compares to payroll taxes for employees. You’ll learn who must pay the SE tax, how to pay it, and tips to stay compliant when you work for yourself.

What is the self-employment (SE) tax?

In addition to federal and applicable state income taxes, everyone must pay Social Security and Medicare taxes. These two social programs provide you with retirement benefits, disability benefits, survivor benefits, and Medicare health insurance benefits.

Many people don’t realize that when you’re a W-2 employee, your employer must pick up the tab for a portion of your taxes. Thanks to the Federal Insurance Contributions Act (FICA), employers are generally required to withhold Social Security and Medicare taxes from your paycheck and match the tax amounts you owe.

In other words, your employer pays half of your Social Security and Medicare taxes, and you pay the remaining half. Employees pay 100% of federal and state income taxes, which also get withheld from your wages and sent to the government.

When you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

But when you have your own business, you’re typically responsible for paying the full amount of income taxes, including 100% of your Social Security and Medicare taxes.

Who must pay the self-employment tax?

All business owners with "pass-through" income must pay the SE tax. That typically includes every business entity except C corporations (or LLCs that elect to get taxed as a corporation).

When you have a C corp or get taxed as a corporation, you work as an employee of your business. You're required to withhold all employment taxes (federal, state, Social Security, and Medicare) from your salary or wages. Other business entities allow income to pass directly to the owner(s), so it gets included in their personal tax returns.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

You must pay the SE tax no matter if you call yourself a solopreneur, independent contractor, or freelancer—even if you're already receiving Social Security or Medicare benefits.

How much is the self-employment tax?

For 2020, the SE tax rate is 15.3% of earnings from your business. That's a combined Social Security tax rate of 12.4 % and a Medicare tax rate of 2.9%.

For Social Security tax, you pay it on up to a maximum wage base of $137,700. You don't have to pay Social Security tax on any additional income above this threshold. However, this threshold has been increasing and is likely to continue creeping up in future years.

However, for Medicare, there is no wage base. All your income is subject to the 2.9% Medicare tax.

So, if you're self-employed with net income less than $137,700, you'd pay SE tax of 15.3% (12.4% Social Security plus 2.9% Medicare tax), plus ordinary income tax.

Remember that your future Social Security benefits get reduced if you don't claim all of your self-employment income.

What is the additional Medicare tax?

If you have a high income, you must pay an extra tax of 0.9%, known as the additional Medicare tax. This surtax went into effect in 2013 with the passage of the Affordable Care Act (ACA). It applies to wages and self-employment income over these amounts by tax filing status for 2020:

  • Single: $200,000 
  • Married filing jointly: $250,000 
  • Married filing separately: $125,000 
  • Head of household: $200,000 
  • Qualifying widow(er): $200,000

What are estimated taxes?

As I mentioned, when you’re an employee, your employer withholds money for various taxes from your paychecks and sends it to the government on your behalf. This pay-as-you-go system was created to make sure you pay all taxes owed by the end of the year.

You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

When you’re self-employed, you also have to keep up with taxes throughout the year. You must make quarterly estimated tax payments if you expect to owe at least $1,000 in taxes, including the SE tax.

Each payment should be one-fourth of the total you expect to owe. Estimated payments are generally due on:

  • April 15 (for the first quarter) 
  • June 15 (for the second quarter) 
  • September 15 (for the third quarter) 
  • January 15 (for the fourth quarter) of the following year

But when the due date falls on a weekend or holiday, it shifts to the next business day. Your state may also require estimated tax payments and may have different deadlines.

How to calculate estimated taxes

Figuring estimated payments can be extremely confusing when you’re self-employed because many entrepreneurs don’t have the faintest idea how much they’ll make from one week to the next, much less how much tax they can expect to pay. Nonetheless, you must make your best guesstimate.

If you earn more than you estimated, you can pay more on any remaining quarterly tax payments. If you earn less, you can reduce them or apply any overpayments to next year’s estimated payments.

If you (or your spouse, if you file taxes jointly) have a W-2 job in addition to self-employment income, you can increase your tax withholding from earnings at your job instead of making estimated payments. To do this, you or your spouse must file an updated Form W-4 with your employer.

The IRS has a Tax Withholding Estimator to help you calculate the right amount to withhold from your pay for your individual or joint taxes.

How to pay estimated taxes

To figure and pay your estimated taxes, use Form 1040-ES, Estimated Tax for Individuals, or Form 1120-W, Estimated Tax for Corporations. These forms contain blank vouchers you can use to mail in your payments, or you can submit funds electronically.

When you have a complicated situation, including having business income, one of your new best friends should be a tax accountant.

For much more information about running a small business successfully, check out my newest book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers. Part four, Understanding Business Taxes, covers everything you need to know to comply and stay out of trouble.

From personal experience, I can tell you that when you have a complicated situation, including having business income, one of your new best friends should be a tax accountant. Find one who listens well and seems to understand the kind of work you're doing.

A good accountant will help you calculate your estimated quarterly taxes, claim tax deductions, and save you money by helping you take advantage of every tax benefit that's allowed when you're self-employed. In Money-Smart Solopreneur, I recommend various software, online services, and apps to help you track expenses, deductions, and tax deadlines that will keep your business running smoothly.

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The Sweet Spot

“Success can get you to the top of a beautiful cliff, but then propel you right over the edge of it.” As a Mustachian, there’s a good chance that you are a bit of an overachiever.  Maybe you fought hard to get exceptional grades in school, or perhaps you have always dominated in your career […]

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3 Tax Scams You Need to Watch Out For

According to the Internal Revenue Service (IRS), there was a 400% increase in phishing and malware incidents during the 2016 tax season. And tax scams extend far beyond email and malware to include phone scams, identity theft and more.  While the April 15 filing deadline still feels far away, as Yogi Berra said, “It ain’t… Read More

The post 3 Tax Scams You Need to Watch Out For appeared first on Credit.com.

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Bible Verses About Wealth

These Bible verses about wealth talk about how God has promised to provide for us, and why the desires for wealth can be so deceiving and easily become a false idol in our lives.

The post Bible Verses About Wealth appeared first on Bible Money Matters and was written by Peter Anderson. Copyright © Bible Money Matters – please visit biblemoneymatters.com for more great content.

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7 Ways to Make Frugality a Joyful Choice, Not a Burden

Frugality is quite popular these days, but it’s hardly a novel concept. Frugality kept many families going during wartime and the Great Depression, and it has the power to improve our homes and lives today.

While circumstances can force us into frugality, and that’s not much fun, you can also enjoy life while being frugal. Here are some great ways to make a thrifty lifestyle a joyful choice and not a burden.

First, clarify your why

Why do you want to be a frugal person? What benefits will a frugal lifestyle bring that you can’t find any other way? To make your frugality a joyful choice, you need to have a solid reason for it.

Most of us don’t live frugally for the sheer fun of it—at least not at first. You probably have a reason to be frugal. Perhaps you’re saving for a downpayment on a home, paying off student loan debt, or reducing your budget to enjoy greater career freedom.

You must have a reason for being frugal that is greater than your desire to spend money.

Clarify why you're planning to be more frugal. (You might have several reasons). Every time you struggle with forgoing a purchase to save money, remind yourself of the purpose behind it. You must have a reason for being frugal that is greater than your desire to spend money.

Your reasons are likely things that will add to your happiness one day. Buying a home, becoming debt-free, or cutting back on work hours may significantly improve your life, so those goals are worth the effort to be frugal.

7 strategies to make frugal living more enjoyable

1. Try a frugality challenge

Join a no-spend challenge where you only spend money on essentials for a month to see how much money you might save. This kind of thing isn’t meant to be a long-term change in habits, although some people might continue after the challenge is over.

The point of a frugality challenge or no-spend month (or year) is to reset your baseline. Change the default of how much money you spend each month. You may struggle at first, but it gets easier the longer you avoid spending.

When the month of extreme frugality is over, don’t automatically resume spending at your former levels.

When the month of extreme frugality is over, don’t automatically resume spending at your former levels. Take some time to evaluate how you felt, what triggers tempted you, and what things you discovered you don’t really need or want anymore.

It’s OK if you start spending a bit more again, but be mindful about what you purchase. It’s like the Konmari method of decluttering your house, except with your finances: Let go of what is no longer serving you, and joyfully spend on the things that matter.

2. Focus on gratitude

Gratitude can make you a happier person. When you think about what you’re grateful for, it’s pretty hard to dwell on what you don’t have. Research has shown people who regularly express gratitude often feel more positive emotions, savor good experiences, and improve their health.

It’s much easier to save your money when you focus on your blessings. Writing a list of things you’re grateful for daily can help you feel more content and less likely to crave the temporary high of buying something new.

You can still have so much without spending a lot.

Frugality doesn’t take away things you enjoy. Yes, it often means shopping around to get a lower price or doing without something you didn’t need. But you can still have so much without spending a lot.

Examples of things that might be on your gratitude list:

  • Running water
  • Internet service
  • Virtual connectivity to friends and family across the globe
  • Food and drink
  • Modern conveniences (electricity, dishwashers, lawnmowers, etc.)
  • Family
  • Friends
  • Nature

3. Notice the benefits of frugality

The longer you follow a frugal lifestyle, the more benefits you’ll observe. As you forgo spending on things that perhaps were luxuries, pay attention to the benefits you experience, whether expected or unexpected. Some of the common benefits you might see include:

  • Feelings of joy for the small things
  • Preferring homemade meals to dining out
  • Appreciation for what you have
  • No more temptation to buy to impress people
  • Learning a new skill
  • Adopting other, healthier habits

The more you appreciate the benefits of your frugality, the easier it will become to keep following frugal principles.

4. Make bargain-hunting a game

When you need or want something, look for low- or no-cost ways to get it. Buy Nothing groups, Facebook Marketplace, local garage sales, or thrift stores may have the item you’re seeking for much less (or even free).

Frugality often means spending a little more time researching the item you need before rushing out and buying it. But you usually don’t need something instantly and can afford to wait a few days, weeks, or months. That time can save you a great deal of money. Plus, you get to enjoy the satisfaction of snagging a great deal.

5. Enjoy learning to DIY

If you’re just starting with frugal living, you may find yourself trying to fix something you usually would have replaced. Do-it-yourself tasks are an opportunity to learn.

Look at frugality as a part of your identity rather than a difficult phase.

When you choose to repair or reuse something rather than replacing it with a new one, think about how cool it is to learn something new. My husband loves YouTube for teaching him a ton of valuable skills, such as how to replace car brakes. Yes, this takes more of his time in a hands-on way, but he enjoys the challenge, saves money, and guess what? Now he knows how to do the same job in the future, saving us money for years to come.6. Make frugality your identity, not a phase

Look at frugality as a part of your identity rather than a difficult phase. Habits expert James Clear writes about this in his bestselling book Atomic Habits: “To change your behavior for good, you need to start believing new things about yourself. You need to build identity-based habits.”

For instance, rather than stating your goal as “I want to save $200 this month,” try identifying yourself as someone who is joyfully frugal. Reframing your identity by saying, “I’m a frugal person” can be more effective than thinking, “I can’t wait until I can start spending money again.” All those little spending decisions are more manageable when you view everything as a means of honoring your values rather than temporarily denying yourself something.

7. Cultivate an abundance mindset

Consider how you talk about money in your day-to-day life. Try to pay attention to what you think and say about money throughout a typical week.

You’re making an intentional choice to prioritize what matters.

If you often say things like “I can’t afford that,” you’re negatively framing your frugality. But if you say something like “I choose not to spend money on that,” you put the power in your hands. You’re making an intentional choice to prioritize what matters.

There’s a subtle yet essential difference in these perspectives. If you have a scarcity mindset where you don’t have enough and you always want more, it won’t get you anywhere. But if you cultivate an abundance mindset, you’ll see opportunities for the future and believe in your ability to realize those opportunities.

Frugality is fun … for real!

Honestly, frugality is a fantastic lifestyle that brings me endless joy every day. It’s exciting to look for ways to save money without sacrificing any of the things you love to do. I hope you’ll start finding the joy in frugality too.

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