Going from “employee” to being your own boss brings some significant changes professionally and personally. One of the most significant to become accustomed to is no longer having certain taxes neatly taken from your paycheck from your employer.
As a self-employed individual, not only are you responsible for directly submitting the income tax you owe to the federal, state, and local governments, you’re also responsible for paying self-employment tax.
According to IRS.gov, “Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.”
Similar to the FICA tax that wage earners working for employers pay, the self-employment tax rate for 2015 is 15.3 percent on your first $118,500 of net income and then 2.9 percent on net income beyond that. The rate consists of two parts: 12.4 percent for social security and 2.9 percent for Medicare. While employees only have 6.2 percent of the social security portion of FICA tax deducted from their paychecks (their employers pay the other half), self-employed individuals must remit the full 12.4 percent of the social security tax in addition to the full Medicare tax amount.
Most self-employed individuals, because their tax isn’t withheld from paychecks, must estimate their self-employment and income tax amounts due and pay them on a quarterly basis. Not paying the taxes on time or not paying enough could result in financial penalties.
According to SCORE certified mentor Tim Frees, “It is important to keep your accounting records current so you know the amount of income (or loss) at any point in time. The actual self-employment results should be compared to your budget to identify shortfalls in revenue and/or overspending. Monitoring actual results compared to your budget aids in identifying overspending and/or revenue shortfalls where corrective action and/or adjustments may be necessary.”
Adjusting to planning for and paying self-employment tax doesn’t come easily for all small business owners. It takes discipline and the ability to forecast revenue and expenses with some degree of accuracy.
“Having accurate and up-to-date accounting records is essential to project your self-employment quarterly income tax liability,” shares Frees. “A local accountant and/or CPA can assist you with income tax projections and the correct amount of quarterly income tax payments.”
You can find more information about self-employment tax on the IRS.gov website. Also be sure to check with your state and local governments about income tax requirements and due dates so you don’t find yourself falling behind on those obligations.