Tax calculations can be one of the most overwhelming processes you have to undergo every year. Calculating your taxes when you’re self-employed is quite a daunting process because you have to generalize several figures on your own. If you work in a company or have an employer, they’re the ones responsible for calculating your taxable income, informing the IRS, and automatically withholding a part of your salary to pay for your taxes. However, if you are working as a freelancer or own a small business, you need to figure out the whole deal yourself. Take a look at the following guide that can make tax time a lot more tolerable.
If you used to work for any employer, you must know that there’s a portion of your income that gets deducted for taxes. This part pays the bills for Social Security and Medicare. The percentage is the same whether you’re self-employed or not; the only difference with self-employment is that you play the roles of both the employee and the employer.
Your net wages are subject to Social Security tax by 12.4% and Medicare tax by 2.9%, which amounts to 15.3%. This amount is divided equally between you and your employer, in which case you only pay 7.65% of your net income for taxes. If you’re self-employed, you have to pay the total amount of 15.3% on your total net income. In 2021, if your net earnings amount to $142,800, that’s the portion that’s subject to Social Security tax. There’s no such limit for Medicare tax calculation, but you can be subjected to an extra 0.9% if you earned more than $200,000 as a single person. That figure changes in other joint-filing cases. If you’re married and filing jointly, it’s $250,000 and if you’re married and filing separately, it’s $125,000.
How to Calculate Self-Employment Tax
Self-employment tax applies if you earn $400 or more as net wages. To calculate your taxable income, you should deduct any business expenses from your gross profit. The tax calculator from Bonsai can give you insight into how reliable services are able to provide you with accurate calculations according to the state you live in. The difference between the two figures is your net income, which is then multiplied by 92.35% and that final amount is subject to self-employment tax. When you’re self-employed, you’ll be required to provide a tax estimate each quarter.
You’ll have to keep exact records of how much money you spent and how much you earned. Report the income and expenses for your business using a Schedule C form. Some of your clients may send you 1099 forms that include any amount of money they paid you annually. These forms inform the IRS that you are self-employed and subject to self-employment tax. It’s a must that you don’t delay making your estimated tax payments during the year to avoid any late-payment penalties.
Since you make these calculations four times a year, you’ll have to provide the best estimate based on the tax rate and your net profit. Bear in mind that these estimated amounts should be at least 90% of your taxes during the current year or 100% of your taxes from the previous year.
Finally, it’s time for some good news; you are entitled to tax deductions! These deductions are for business expenses throughout the year. You’re eligible for a home office deduction if you’ve dedicated a space in your house for your business. You can include part of the rent or mortgage expenses, utility bills such as electricity, gas, water, internet, and phone services, and any repairs done to your workspace at home.
You should keep a record of the exact square footage of your home office, which is then calculated as a percentage of your home and that would be multiplied by any bills you receive for your house. That is, if your office takes up 15% of your house, then 15% of your home expenses can be considered a home office deduction. You can also deduct your medical insurance premium if you bought them for yourself and your family, but it may not work in case you were part of your spouse’s insurance plan.
Other deductions include traveling expenses, business courses, advertising, retirement plans, office supplies, and even the self-employment tax itself, where you can deduct 50% of it from your income tax.
Tax season can be intimidating, but after you practice calculating your taxes a couple of times, you’ll get the hang of it. Make sure you report all of your income and remember to keep track of your expenses. You should regularly check if they’re eligible for tax deductions as you can end up saving a lot of money.