Self Employment Tax

Self employment tax is very similar to the tax paid by wage earners. It is a social security and medicare tax that enables the U.S. Government to provide certain facilities to its citizens. Independent contractors, a partner in a partnership, owners of small businesses, a member of a single-member LLC, as well as sole proprietors, amongst others, come under the category of self employed individuals. If you are one these individuals whose net earnings from the self-employment is more than $400 yearly, then the U.S. law expects you to pay Self Employment tax (SE tax). While calculating SE tax, 92.35 percent of the net earnings out of the self employment is considered taxable. One can arrive at the net earnings by deducting the ordinary expenses of the business from its gross income. The following paragraphs presents information on self employment tax rate.

Self Employment Tax Rate

For a wage earner, a part of the social security and medicare tax that he has to pay is borne by his employer. However, as a self employed person, you are responsible for full payment of this tax. The self employed tax rate is 15.3% which can be broken into two components:12.4% and 2.9%. Of these, 12.4% is attributed to social security and 2.9% to the Medicare. The part of net earnings that is subjected to the social security tax is variable and changes annually. For example, social security tax component of SE tax for the year 2009 was applicable only to the first $106,800 of the combined wages, tips, and net earnings. On the other hand, the medicare component is applicable to the total net income.

How to Pay Self Employment Tax

To pay SE tax, a self employed person must have a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN). If you do not have a SSN, then you can apply for it by filling Form SS-5. One can get this form at the local social security office or by downloading it from the Internet.

In case you do not qualify for a SSN, which may happen if you are a non-resident or resident alien, the Internal Revenue Service (IRS) will then assign a ITIN to you. An ITIN can be applied for by filling Form W-7.

The income generated through self employment is not subject to withholding. The owner of such an income must pay SE tax using the method of estimated tax. A self employed individual will have to use this method if, at the time when he files his return, he expects to owe $1,000 or more in SE tax. Refer to Form 1040-ES, in order to figure the amount of your tax. There are factors such as expected adjusted gross income, taxable income, taxes, tax deductions, and credits which must be considered while arriving at the amount of SE tax. Be careful with the calculations, as using an incorrect amount to base your estimated tax payments on can bring you a penalty.

When to pay self employment tax? Each year is divided in four quarters to facilitate easy payment of taxes. The end of each quarter is considered as the deadline for that particular period and one can use electronic federal tax system to avoid a penalty for missing the deadline.

It appears that self employed individuals has to pay a lot in taxes. One of the tax benefits of self employment is that you can deduct all of your health, dental and long-term care insurance premiums, as well as those providing coverage for your spouse and dependents. In practice, these are considered as personal deductions. However, self-employed individuals can claim these as business deductions and get their self employment tax reduced. Business use of home and car are a few additional examples of self employment tax deductions.

For individuals who want to claim credit towards their social security coverage, there are two methods to use. Whatever their net loss or profit from the self employment is, net earnings out of it, which in turn will be helpful in calculating self employment tax, can be arrived at by referring to Form 1040 and Schedule SE instructions.

Not all organizations and self employed individuals pay the same self employment tax. Churches and church-controlled organizations can elect exemption from self employment tax. On the other hand, professionals such as farmers and fishermen have different requirements which can be referred to by going through publication 505, Tax Withholding and Estimated Tax.