So many self-employed individuals have asked me, “Why are my taxes so high?
Individuals with their own business, including single member LLC’s, not only pay federal income taxes at their appropriate tax bracket, but they will also be liable for the Social Security and Medicare tax on the earnings of the business. As an employee receiving a W-2 from an employer, your part of Social Security and Medicare taxes are withheld from your wages and your employer covers the other part. However, as a sole proprietor, you are responsible for all of the Social Security and Medicare taxes.
So, what is self-employment tax? Anytime self-employment tax is mentioned, it only refers to Social Security and Medicare taxes and does not include any other taxes that self-employed individuals may be required to file. Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.
Self-Employment Tax Deduction
You can deduct the employer-equivalent portion of your self-employment tax in figuring your adjusted gross income (this is one half of the total Social Security and Medicare tax). This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your self-employment tax.
As a self-employed individual, it is important to remember you will not only pay federal income tax based on your taxable income, but also the Social Security and Medicare tax associated with the earnings on the business. It is import to understand the tax so your estimated taxes will be properly calculated and you withhold enough money back to pay your quarterly estimate and/or final tax balance.
Also, remember that the health insurance system does not accommodate independent workers well. If you can’t get coverage through a spouse’s plan, you can continue your former employer’s plan at your own expense under COBRA. You may also be eligible for group health insurance through a group.
In addition to maintaining ties to your old company, you should prepare to make networking a full-time job. One of the most important referrals you can get is for a good accountant. Knowing what to write off as business expenses can save enough on your tax bill to make hiring an accountant worth it. Since your employer isn’t withholding taxes anymore, you’ll need to pay estimated taxes four times a year.
This article was originally published in Illuminations: Facts & Figures from people with a brighter way, a Rea & Associates enewsletter, 10/24/2012.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.