Self employment tax is only one of the things you need to take into consideration when you are looking at giving up paid employment and becoming an entrepreneur. You will need to keep track of your income and expenses in order to help you calculate the amount of income tax you owe.
Definition of Self Employed
According to the Internal Revenue Service, a person is self-employed if they meet the following criteria:
- You are in business on your own (as either a sole proprietor or independent contractor)
- You operate a business with one or more business partners
Part Time Business
To fit the definition of self-employed, you don't need to be working in the business on a full-time basis. Even if you only operate your business part-time, you may need to fill in a Schedule SE (Form 1040) to pay the self employment tax.
About The Self Employment Tax
When you work for someone else, a certain percentage of your income is withheld and used to fund Medicare and social security. Self-employed people are required to pay 15.3 percent of their earnings as a self employment tax for this purpose. Unlike salaried workers, you can deduct half this amount when you are figuring out your adjusted gross income (income less all allowable deductions) for tax purposes.
The self employment tax is payable on the first $94,000.00 you earn each year. Of the taxes you pay, 12.4 percent goes to social security, which includes disability payments and money given to seniors and surviving spouses. The other 2.9 percent is used to fund the Medicare portion of the tax.
Who Needs to Pay The Self Employment Tax
If you earned more than $400.00 (net income) from your self-employment activities or $108.28 in church employee earnings, you are required to pay the self employment tax.
Keep Track of Your Expenses
When you are in business for yourself, you can deduct expenses that you need to pay to keep the business running. Be sure to keep receipts for all of them in case you are audited at some point. Here are some examples of items you can deduct:
Start Up Costs
In your first year of doing business, you can deduct up to $5,000.00 costs for your business. These expenses include the following:
- Legal Fees
- Market Research
- Travel for Business Purposes
As a business owner, you can either keep track of your mileage and deduct a flat rate of 44.5 cents for every mile you drove for business purposes or the actual amount you spent for fuel, oil, and maintenance. The purchase price of your vehicle can be written off in a lump sum or depreciated over a number of years. (Your accountant or an income tax software program will be able to help you determine which course of action is the best choice for your particular situation.)
The cost of equipment you buy for the purpose of earning income can be deducted as well. Get a tax break on the cost of:
- Office Equipment (Calculators, Printers, Fax Machines, etc.)
If you incur entertainment expenses as part of your business activities, you can deduct them on your income tax return. In order to qualify as a business expense, make sure that your claim relates to an event that will clearly be considered a business setting. An example of this would be a conference.
If you buy software to be used for business purposes, you can deduct the cost. Small business owners who buy a product off the shelf can deduct the full cost immediately, as opposed to over several years.
By keeping close track of your business expenses, you can reduce the figure for your adjusted gross income. While you should be prepared to pay the appropriate amount of self employment tax, you want to avoid overpaying. Deducting all of your legitimate expenses will keep this cost down.