How to Calculate Self-Employed Tax
Being self-employed comes with many benefits, such as flexible work hours and the ability to choose your projects. However, one of the challenges that self-employed individuals face revolves around tax calculations. It’s fundamental to understand the basics of calculating your taxes to avoid any issues with the Internal Revenue Service (IRS). In this article, we will go through a step-by-step guide on how to calculate self-employed tax.
Step 1: Determine Your Net Income
The first step in calculating your self-employment tax involves determining your net income. Start by adding up all your earnings, including fees, commissions, and sales revenue from various sources. Then, find out your total expenses by adding up all your business costs, such as business equipment, office rent, and marketing expenses. Remember to track all your receipts and records to ensure accuracy.
Net Income = Total Earnings – Total Expenses
Step 2: Calculate Your Self-Employment Tax
Now that you’ve found out how much you earned during the tax year, it’s time to calculate the amount you owe in self-employment taxes. The IRS requires self-employed individuals to pay both Social Security and Medicare taxes under the Self-Employment Contributions Act (SECA). As of 2021, the total combined rate for these taxes is 15.3%, with 12.4% for Social Security and 2.9% for Medicare.
Self-Employment Tax = Net Income x SECA Tax Rate (0.153)
For Social Security taxes, there’s an income limit or cap ($142,800 in 2021), which means that after a certain threshold, you don’t need to pay Social Security tax on any additional income.
Step 3: Calculate Your Adjusted Gross Income (AGI)
After determining your overall self-employment tax amount, you should also factor it into your overall tax return since half of your self-employment tax is deductible. To do this, you need first to find out your Adjusted Gross Income (AGI).
AGI = Total Earnings – (Total Expenses + ½ x Self-Employment Tax)
Step 4: Estimate Your Quarterly Taxes
To avoid penalties from the IRS, self-employed individuals are required to pay estimated taxes on a quarterly basis. By calculating your AGI, you can use online tax calculators or consult with a tax professional to determine how much you should pay in quarterly taxes. To make these payments, use Form 1040-ES, Estimated Tax for Individuals.
Being self-employed brings many benefits and challenges, so it’s essential to be prepared when it comes to your tax responsibilities. Follow the guide above to calculate and appropriately handle your self-employed taxes. While this article provides valuable information, individual circumstances vary, and it’s recommended to consult with a tax professional to ensure that your specific tax needs are met.