On Your Own, and Paying for It
When you own your own business, it seems like you always have to pay to play, doesn't it? The fact is, starting a small business will cost you a pretty penny, but it's also worth it. After all, you can't put a price on freedom… unless, of course, you are the IRS.
I bet that back when you worked for the man, your paychecks always felt a little light. Of course, among other reasons, that is because your bosses withheld estimated taxes. Now that you're on your own, you are responsible for paying your own taxes to the government each quarter—not only your income tax, but a self-employment (SE) tax as well.
Self-employed people are both the employer and the employee, which means paying double when it comes to some taxes.
Before you get all hot and bothered, you should know that you've been paying these same taxes all along.
Self-employed tax is your mandatory annual contribution to Social Security and Medicare; nearly all wage earners have this contribution automatically withheld, but as a solopreneur you will need to figure out what you owe, and then pay Uncle Sam directly.
Okay, now comes the hitch: when you were employed, your boss paid a matching contribution. You and your employer split the taxes 50/50. As you might have guessed: Now that you're self-employed, you are on your own and your contribution to Medicare, Medicaid, and Social Security will be doubled. In essence, you are now your own employer and the employee, and you need to pay up if you want to fend off the IRS.
So what's the good news? Self-employment tax is fairly straightforward. Take a few minutes to learn the ins and outs, and follow the simple steps outlined below to make sure you are prepared to pay Uncle Sam his share.
How Much Tax Do I Owe?
You can calculate your self-employment tax using a Schedule SE, or you can follow the broad guidelines provided by the IRS. Currently, the federal Social Security tax rate is 13.3% for income up to $110,000. The Medicare tax rate is 2.9%. This means that if you earn less than $110,000 you will owe a total of 16.2% of your gross income as SE tax; if your net income exceeds $110,000 then you will need to pay 2.9%, the Medicare tax rate, for every additional dollar earned.
Sounds like a lot of dough, but there's a bright side. When it's time to file, you can subtract one half of your contribution to Social Security from your gross income. Here's the fine print: the deduction must be taken from your taxable gross income and used to determine your new adjusted gross income. You cannot list your contribution to Social Security as an itemized deduction on your Schedule C form.
How to Pay Self Employment Tax
Similar to your income tax, you will be required to pay estimated SE tax every quarter. You don't need an Employer Identification Number or any special designation from the IRS, you simply pay using your own Social Security Number.
When you are self-employed, you owe estimated taxes on the 15th day of April, June, September, and December
As a solopreneur, you owe estimated taxes on the 15th day of April, June, September, and December. As you know, the IRS loves to pick nits: don't pay a day late, and don't ever underpay if you can help it, or you'll be in for a nasty surprise when you file your return. If you do underpay, then at the end of the year you will owe Uncle Sam the difference plus interest.
I recommend that you open a separate savings account for your estimated quarterly payments and contribute to the account every month. When you're focused on your business—finding clients, finishing projects, you know, actual work—it's easy to let a quarterly payment slip your mind. It's not the end of the world if you forget to pay, but it's a waste of money.
See? It's not so hard. And if you're still not certain, and you want to play it safe, then call a CPA or tax preparer ASAP.