George Robertson, CFP, CRPS, AIF

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"Taxed" by Self-Employment?

Along with the independence of entrepreneurship comes responsibility and, for many business owners, that means paying self-employment tax (SE tax) in addition to regular tax. You are considered self-employed if you run your business either by yourself or with a partner. SE tax covers both Social Security and Medicare taxes, which wage earners also pay. Their taxes are deducted from their pay, and then matched by their employers, who handle payment to the IRS. Entrepreneurs like yourself are on your own.

Who Has to Pay?

If your business is structured as a C corporation, you will not owe SE tax, but you will be subject to corporate tax. SE tax may apply to other business entities, such as sole proprietorships, partnerships, and limited liability companies (LLCs).

For tax purposes, you will still be considered self-employed even if you only have a part-time business or consider yourself an independent contractor. The key determining factors are business structure and income, not time. If you earn $400 or more on your own, you must file Schedule SE along with your tax return. Also bear in mind that if you are considered self-employed and you have employees, you must pay employment taxes, including federal income, Social Security, and Medicare taxes.

In 2010, the SE rate is 15.3% on self-employment income up to $106,800. This umbrella tax has two parts: a 12.4% Social Security tax, covering old-age, survivors, and disability insurance; and a 2.9% tax for Medicare.

There is a deduction to help soothe the SE tax sting. You may lower your income tax by deducting half of your SE tax when calculating your adjusted gross income (AGI).

For SE tax purposes, your net earnings represent your gross business earnings minus permissible business deductions and depreciation. The following types of income generally will not count toward your net earnings, unless such income stems from your business operations:

  • stock dividends
  • bond interest
  • loan interest
  • real estate rental income
  • limited partnership income

Estimated Tax Payments

The IRS describes the federal income tax as a "pay-as-you-go" tax, which requires business owners like yourself to plan ahead. If you anticipate owing tax of $1,000 or more, you'll need to estimate the amount and pay it throughout the tax year, typically in quarterly installments. So, if you are self-employed and do not have income tax withheld, you'll need to pay estimated tax equal to 90% of your current-year tax liability or 100% of what you paid the previous year. If your AGI on last year's return was more than $150,000, the percentage requirement increases to the lesser of 110% of last year's tax or 90% of this year's tax. Please bear in mind that failure to pay estimated taxes may result in penalties.

For more information on the self-employment tax, visit the IRS online at www.irs.gov and consult our Publication 533. To help ensure you are in compliance, consult your tax professional for specific advice.

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