If you own your own business (not a corporation), you are considered to be self-employed, and you must pay self-employment taxes. These self-employment taxes are taxes paid by self-employed individuals to the Social Security Administration, for Social Security and Medicare. But there's more to this subject than that. In this article, we'll discuss how self-employment taxes are calculated, what they are based on, and how they affect business owners in various types of businesses, and family-owned businesses.
The IRS says:
You are self-employed if either of the following applies to you:
- You carry on a trade or business as a sole proprietor; or
- You are a member of a partnership or limited liability company that files a Form 1065, U.S. Return of Partnership, that carries on a trade or business.
As usual, there's more to it than this simple statement. Read more to determine if you are self-employed.
Self-employment taxes are taxes paid to the Social Security Administration for Social Security and Medicare eligibility. The amount of these taxes is based on net earnings from self-employment (business ownership), for a business which is not a corporation. The tax rate is similar to the rate employers and employees pay together for FICA taxes.
The self-employment tax rate is 15.3% on net earnings from employment, but the Social Security portion of this tax is capped at the Social Security maximum income each year.
In attempt to boost taxpayer income - and thus encourage spending - the Tax Relief Act, signed by President Obama in December 2010, reduces withholding for employees. This reduction is an attempt to stimulate consumer spending and get the economy back on track.
In addition to this reduction in employee withholding, self-employment taxes (Social Security and Medicare) have also been reduced by 2%. Self-employed persons, who pay both halves of the Social Security tax through the self-employment tax, will pay a combined rate of 10.4% (the employer's 6.2% plus the employee's 4.2% rates), instead of the 12.4% rate in past years.
Self-employment taxes and employment taxes are essentially the same thing. They both are taxes for Social Security and Medicare, based on earnings from self-employment or employment, and the rates are essentially the same. But there are some slight differences you should know about.
Self-employed business owners, just like employees and their employers, pay Social Security and Medicare taxes based on income. In the case of self-employed individuals, the income is from business profits. The Self-Employment Contributions Act (SECA) defines the requirements for paying this tax.
The amount of self-employment taxes a business owner must pay are determined using Schedule SE. The net earnings ("profit") from the business are the basis for this calculation.
Your self-employment taxes are added to your income taxes on your personal income tax return.
Net earnings are calculated generally by starting with gross income from the business and subtracting deductions and depreciation allowances. This general calculation differs slightly depending on the business type.
If you are a sole proprietor, member of an LLC, or a partner in a partnership, you are considered to be self-employed, and your portion of earnings from your business is subject to self-employment tax. This article gives details on each of these business types.
If you are self-employed and also an employee of someone else, both incomes are included to determine the total amount of Social Security and Medicare tax you must pay. Employment income is considered first; an example is included in this article.
Help is available from the Social Security Administration, the IRS, and your friendly local tax advisor. You can also ask a question on the Forum.