Self-Employment Taxes: What You Should Know

Self-employment tax is frequently the largest component of tax liability for someone engaged in a trade or business. In fact, this tax is owed on business profit even when no regular income tax is due. Self-employment tax is paid in addition to any regular income tax assessment.
Self-employment tax refers to taxes for Social Security and Medicare by taxpayers who work for themselves. It is a substitute for Social Security and Medicare taxes withheld from the pay of wage earners and paid by their employers.
You are self-employed when engaged in a trade, business or profession in which you offer products or services for payment. This applies to part-time endeavors. All independent contractors are self-employed, and their earnings are subject to self-employment tax. The self-employment tax was lowered to 13.3% in 2011 due to a temporary 2% reduction of federal tax on Social Security.
Self-employed individuals don’t have tax withheld from paychecks like employees. Consequently, self-employed individuals are missing withholdings for payment of Social Security and Medicare taxes as well as regular income tax.
They have to pay their tax liability directly to the U.S. Treasury.
When the self-employed make estimated tax payments throughout the year, the amounts paid include self-employment tax in addition to regular income tax. Estimated tax payments are normally four equal amounts during the year. A penalty is assessed on underpayment of estimated tax. Therefore, paying your entire self-employment tax liability late in a year normally incurs a penalty. However, self-employed individuals with fluctuating income throughout the year may send unequal payments and file Form 2210 with their tax returns.
A more common safe-harbor provision for estimated tax payments that averts penalty is payment that corresponds with tax liability of the preceding year. But using this method is often unsuitable for the newly self-employed who earned wages in prior years. Form 2210 may be the right option in such situations to avoid remitting excessive estimated tax.
Determining estimated tax payments that include self-employment tax requires a computation of business profit. Ordinary and necessary business expenses are deductible against money received. Accurate records of expenses are therefore essential to limiting tax liability. Most expenses commonly incurred and appropriate for a particular trade or business are deductible against gross receipts.
An accountant can provide valuable advice about expense records for the self-employed. For example, capital expenditures for fixed assets with long useful lives are recorded separately from other expenses. Deduction of automobile expense requires a mileage log for each vehicle, indicating the number of miles, date and business purpose.
Self-employment tax also applies to someone owning a single-member limited liability company or who is an active partner in a business partnership. The tax is payable when net income from self-employment is $400 or more per year. Self-employment tax is even owed by individuals who have income from a trade or business when they are already receiving Social Security benefits.