Individuals who are self employed are required to pay a higher rater than those people who work for other companies. According to the Internal Revenue Service, you may be self employed if you’re a sole proprietor of a business, have a joint venture with your spouse, you’re an independent contractor or you are a partner of a trade or business.
Self-employment tax includes both Medicare and Social Security taxes, the latter of which contributes to your Social Security benefits once you reach the age of retirement. For example, the federal self-employment tax rate in 2011 was 13.3% (10.4% for Social Security and 2.9% for Medicare), but a temporary 2% reduction in self-employment tax was expired for tax years 2013 and 2014. If you have yet to file your tax return for 2014, expect to pay a rate of 15.3%.
For the 2014 tax year, the first $117,000 of income, including wages, tips and other income, isn’t subject to Social Security or self-employment taxes. However, you will still have to pay taxes on the Medicare portion of the self-employment tax even if you make less than that amount. Use these percentages to calculate your self-employment tax.
Because of deductions and credits, estimating how much tax you’ll owe to the federal and state government, it’s wise to set aside more than you think you’ll owe for the current tax year. Many tax professionals recommend setting aside 20% of your income for this purpose. This ensures you tax bill is covered when April rolls around, and you can use the rest of the money like a refund.
You can do this by making quarterly payments to the IRS, which holds the money in an account and will give you a refund from those funds if you’ve saved more than your employment tax comes to, using Form 1040-ES, Estimated Tax for Individuals. You can also set aside that money in a bank account to accumulate interest during the fiscal year.
Estimating self-employment tax can help you to avoid unnecessary fees from the IRS. If your self-employment tax is less than $1,000 annually, you do not have to make quarterly payments to the Internal Revenue Service. However, you may be fined by the IRS if the amount you owe them is over $1,000 per year and you haven’t made estimated quarterly payments during the tax year.