Self- employed individuals have the perks of being their own boss such as making their own hours and determining what work to take on. On the flip side, they also have the responsibility that comes with operating a business, along with the added expense of self-employment taxes. Which leads to the question of the day...What is self-employment tax anyway? It is comprised of 2 taxes:
Social Security Tax - This amount is paid to fund social security. Each American pays 6.2% of their wages for social security tax up to a maximum income amount. For 2013, the maximum amount is $113,700. The maximum amount increases to $117,000 for 2014. After an individual reaches the maximum income level, there is no additional Social Security tax.
Medicare tax - This amount is paid to fund Medicare. Each American pays 1.45% of wages for Medicare tax and there is no maximum level as compared to Social Security tax. In fact, in 2013 we saw a .9% surtax approved on employment earnings over $200,000 for individuals ($250,000 for married couples).
All working Americans pay these taxes. When an individual is employed and receives a paycheck, the employer withholds the tax and remits it to the government on the employee’s behalf. Individuals receiving W-2s never really “see” the money. Self-employed taxpayers should set money aside to pay these taxes.
Many people do not realize the employer also pays tax on the employee’s behalf. Generally speaking, an employee pays the above taxes and the employer also pays 7.65% of an employee’s wages in payroll taxes. So what happens if you are self-employed? If you are self-employed you are responsible for the employee portion of the tax (7.65% of self-employed income) AND the employer portion of the tax (7.65% of self-employed income) for a total payment of 15.3% of self-employed income up to the limit. Yikes! That seems like a lot, right? An employer is able to deduct payroll taxes it pays, thereby reducing taxable income. The benefit is extended to self-employed persons as well. They may take half of what they pay in self-employment tax as a deduction against their taxable income.
Many self-employed taxpayers are caught off guard at tax time and have not prepared for the added burden of self-employment tax. To avoid this predicament we recommend:
Participating in comprehensive tax planning with a C.P.A.
Preparing quarterly income tax projections with a C.P.A.
Making quarterly safe harbor estimated tax payments.
Minimizing taxable income by maximizing business deductions.
At Kraft and Company, PLLC we work with many self-employed persons and are available to meet and discuss strategies for individuals working hard in their own businesses. Please visit our website for more information: www.kraftcpa.com.