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Introduction to Self-Employment Taxes
It's that time of the year again, and now you should be thinking about preparing your tax returns for the end of the year. Most individuals cringe at the thought of paying taxes, especially if they work as freelancers or independent contractors (self-employed). That is, self-employed individuals have to pay the full amount of social security and Medicare tax, which is half of what an employee or a business entity pays. But wait, don't fret! All is not lost! You can significantly lower the amount of self-employment taxes that you pay by first knowing how to correctly calculate self-employment tax. Second, you must know what types of expenses are deductible, which in turn lowers your taxable wages.
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What is Self-Employment Tax?
Self-employment tax - also know as SE tax - is the tax rate imposed on self-employed individuals such as freelancers and independent contractors. The SE tax is based on the combined rate of Social Security (12.4%) and Medicare (2.9%) tax for the 2010 year.
Therefore, self-employed individuals will pay a total of 15.3% per SE tax guidelines. Furthermore, there is a limit on taxable wages on the Social Security portion, which is $106,800 for the 2010 year. On the other hand, there is no cap on the amount of wages that are taxable by Medicare.
Basically, self-employed individuals are responsible for paying the entire Social Security and Medicare taxes as described above. If you are an employee, you only pay half of the Social Security (6.2%) and Medicare (1.45%) rates. Alternatively, your employer is responsible for paying the other half (Social Security 6.2% and Medicare 1.45%). Because you are considered both the employee and the employer, then it is considered the responsibility of the self-employed individual to pay the combined tax rate of 15.3%.
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How to Compute Self-Employment Tax
Knowing how to compute self-employment taxes will take the anxiety out of paying the IRS. All self-employed individuals are responsible for paying self-employment taxes on net earnings of $400 or more. Nonetheless, if you need to know how to calculate self employment tax, you can follow the steps below:
2. Then multiply your net earnings by 92.35% (or 0.9235). This is the portion of your net earnings that is subject to self-employment taxation only.
3. Now, take your adjusted net earnings figure and multiply it by the Social Security rate of 12.4%. Remember, there is a limit on net earnings if the number exceeds $106,800. That is, the Social Security portion is only applicable to the first $106,800; any excess is not subject to taxation.
Please continue to Page 2 for more on How to Compute Self-Employment Taxes.
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Tips on How to Compute Self-Employment Taxes If you are a freelancer or independent contractor (self-employed), then this article is for you. Learn how to compute self-employment taxes before tax season catches you off guard.
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More on How to Compute Self-Employment Taxes
5. Finally, take your Social Security calculations and your Medicare calculations, then add them together. This will give you your total amount owed in self-employment tax.
Here is an example on how to compute self employment tax:
Business Income: $200,000
Business Expenses: $50,000
Medicare Tax: 2.9%
Social Security Tax: 12.4%
- $200,000 – $50, 000 = $150,000
- $150,000 x .9235 = $138,525 ** (Exceeds social security limit of $106,800)
- $106,800 x 0.124 = $13,243.20
- $138,525 x 0.029 = $4,017.22
- $13,243.20 + $4,017.22 = $17,260.42, Total SE Tax
Shortcut Tip: If net earnings are less than $106,800, then just multiply it by the total self-employment rate of 15.3%
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Why Business Expense Calculations Are Important
Calculating business expenses accurately is very important relative to the amount of self-employment tax that you have to pay. Remember, one of the first steps that you must do when you calculate self-employment tax is to deduct expenses. This lowers the amount of income that would be available for taxation. Therefore, it is essential that you understand what expenses are considered deductible, and keep quantifiable records to support your expense calculations.
The IRS allows all expenses to be deductible on your taxes if they are deemed to be both “ordinary” and “necessary” during the normal course of business. Specifically, an ordinary expense is an expense that is accepted and common to your business industry. Likewise, necessary expenses are defined as being appropriate and helpful to your business.
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Filing your individual US tax return 1040 – freedigitalphotos.net/Arvind Balaraman
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