Does self-employment still get taxed? This is a question that many people ask themselves when they consider starting their own business. In short, the answer is yes. However, the process of taxation is different for self-employed individuals than it is for those who are employed by someone else. In this article, we will examine the process of self-employment taxation, including why it’s necessary, how it works, and what recent changes in the tax code mean for self-employed individuals.
Why Self-Employment Taxation Is Necessary
To understand why self-employment taxation is necessary, let’s first examine how taxes work for individuals who are employed by someone else. When someone is employed by a company, the company is responsible for deducting a certain amount of money from their paycheck each pay period. This money is used to pay various taxes, including Social Security and Medicare taxes.
For self-employed individuals, however, there is no employer to deduct these taxes. This means that self-employed individuals are responsible for paying these taxes themselves. To ensure that they do so, the government has implemented a self-employment tax, which applies to anyone who earns self-employment income.
Self-employment tax is calculated based on the net income of the self-employed individual. This includes both business income and any income earned from other sources, such as investments or rental properties. The tax rate for self-employment tax is 15.3%, which includes both the Social Security and Medicare taxes that would normally be deducted by an employer.
How Self-Employment Taxation Works
Now that we understand why self-employment taxation is necessary and how it’s calculated, let’s take a closer look at how the process of self-employment taxation works.
First, self-employed individuals must keep track of their income throughout the year. This includes all income earned from self-employment, as well as any other income earned. Once the year is over, the self-employed individual must file their taxes using a form called Schedule C.
Schedule C is used to report self-employment income and expenses. The net income from Schedule C is then used to calculate the self-employment tax. Self-employed individuals must also file a form called Schedule SE, which is used to calculate the actual amount of self-employment tax owed.
One important thing to note is that self-employed individuals may be required to make estimated tax payments throughout the year. This is because self-employed individuals do not have taxes deducted from their income like employees do. Instead, they must make quarterly estimated tax payments based on their expected income for the year.
Recent Changes in the Tax Code
In recent years, there have been some significant changes to the tax code that have affected self-employed individuals. One of the most significant changes was the Tax Cuts and Jobs Act (TCJA), which was passed in 2017.
Under the TCJA, the standard deduction was increased, which may benefit self-employed individuals who have relatively low income. However, the TCJA also eliminated several deductions that were previously available to self-employed individuals, such as the deduction for unreimbursed business expenses.
Another change that affects self-employed individuals is the Qualified Business Income (QBI) deduction, which allows self-employed individuals to deduct up to 20% of their business income from their taxable income. However, this deduction is subject to certain limitations and restrictions, so it’s important to consult with a tax professional to determine whether you qualify for this deduction.
In conclusion, self-employment still gets taxed, and it’s important for self-employed individuals to understand the process of self-employment taxation. Being aware of the tax code and any recent changes can help self-employed individuals better manage their income and ensure they are complying with all tax laws. If you’re thinking of starting your own business, it’s important to consult with a tax professional to ensure you understand your tax obligations and can plan accordingly.
What is Self Employment?
The term self-employment refers to any individual who earns an income through a product or service that is delivered solely by the individual himself. All self-employed individuals, thus, are not employed by companies or other forms of businesses. Furthermore, a self-employed individual will also incorporate any person who works form himself/herself, as oppose to an employer, but draws an income from a business that they own or operate personally.
Those who are self-employed; however, are not necessarily business owners. A business owner is not required to be hands-on with the day-to-day operations of the underlying company, whereas a self-employed individual must utilize an extremely hands-on approach in order to draw an income and ultimately survive. Based on statistics evaluated and established by the United States Bureau of Labor Statistics, roughly 45% of self-employed businesses survive the first 4 years in business.
Definition of Self-Employment in the United States:
In the United States of America, a person is considered to be self-employed (meaning they are subject to the self employment tax) if that individual is running a business as an independent contractor, a sole proprietorship, as a member of a limited liability company (that does not elect to be treated as a corporation) or as a member of a partnership.
In addition to the generic income taxes paid by all workers who secure an income in the United States, individuals who are self-employed must also contribute Medicare and Social Security taxes to satisfy their self employment tax obligations. The Self-employment tax is established as a part of SECA (the Self-Employment Contributions Act).
What is the Self Employment Tax?
Similar to all employed individuals in the United States, the Internal Revenue Service (the predominant taxing agency in the country) levies an income tax—as well as other taxes—on self-employed individuals.
The self employment tax in the United States is currently set at 15.30%, which is equivalent to the combined contributions of the employee and the underlying employer under the FICA tax. The 15.30% rate attached to the self employment tax consists of two primary parts: 12.4% of the self employment tax is levied for social security and 2.9% of the total 15.30% self-employment tax is levied for Medicare.
The social security portion of the self employment tax is only applied to the first $106,800 of income earned in the 2009 taxable year—this percentage fluctuates based on tax policy and the tax rates for the particular tax year. There is no current limit placed to the amount that is levied under the 2.9% Medicare portion of the self employment tax.
Those individuals who are self-employed are typically eligible for more deductions that typical workers. For instance, travel, computer equipment, cell phones, uniforms, etc. can be deducted as legitimate business expenses under the self employment tax legislation.
All self employment taxes are reported by the individual workers as business income or losses on Schedule C of IRS Form 1040; the self employment tax is the calculated on Schedule SE of IRS Form 1040. The self employment tax must be paid quarterly using form 1040-ES if the estimated tax liability exceeds $1,000.