The freedom of working for yourself comes with a downside - self-employment taxes. In addition, you need more reminders on your calendar for quarterly estimated payments.
What exactly are self-employment taxes? This term generally only applies to Social Security and Medicare taxes. When you work for someone else, these taxes are withheld from your pay and submitted to the IRS. You split the taxes with your employer, but when self-employed you pay the full amount.
Caps and floors
Currently, Social Security tax is 12.4 percent and Medicare is 2.9 percent of income you earn over $400. For 2015 and 2016, Social Security withholdings cap at $118,500. This means you do not need to pay those 12.4 cents on each dollar earned above the threshold.
Medicare taxes, however, have no cap. And in 2013, Congress passed an additional .9 percent Medicare tax rate on income above various thresholds:
- For Individual or Head of Household filers it is $200,000
- Anyone filing Married Filing Joint would pay the added tax on income over $250,000.
That means that the Medicare tax increases to 3.8 percent on income over these proverbial floors.
When self-employed, you can deduct the amount that an employer would have paid when calculating your income tax.
You may also be able to deduct some of your retirement contributions and health care costs. This means take some money out of your earnings to fund retirement. While you may love cleaning houses or building home now, you want to retire from it in your 70s.
Estimated Tax Payments
When do you make these payments? They are due quarterly. To calculate estimated taxes, it is often helpful to look back at what you earned in the previous year.
Overestimate rather than underestimate your income to avoid penalties and interest. If you have not filed tax returns on your 1099 income, now is the time to deal with the problem.
Remember that the IRS receives a copy of every 1099. Then a computer matches the 1099s against reported income looking for discrepancies. If it finds you failed to report income, it will eventually send out a notice of deficiency with what you owe.