How To Do Self Employed Taxes

How To Do Self Employed Taxes – I am not a tax advisor and all information is for educational purposes only. Please consult a qualified professional.

I’m just warning you – this article is going to feel like a math dumpster fire, so before you panic, remember: Any good tax software can help you do this mental jujitsu for you.

How To Do Self Employed Taxes

Everything works, and today I want to show you how self-directed retirement accounts can help you save on your taxes.

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If you’re a W2 employee, your tax status is more or less determined for you (if you’ve filled out your W-4 correctly).

(The IRS has a handy tax withholding calculator to help you complete your W-4, but that tool becomes less useful as your situation gets more complicated.)

If you are a W2 employee, Linda in HR will give you a check every week and calculate the tax amounts accordingly and they will come directly out of your paycheck. In addition to making pre-tax contributions to your employer-sponsored retirement plan (which you absolutely should, to the best of your ability) or your HSA, you are… kind of in debt.

For those of you in your first year of employment who are still working full-time, you may be able to avoid the quarterly nonpayment penalty at all.

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For example, if I owed $20,000 last year and owe $25,000 this year, as long as I pay $20,000 this year, I can avoid the penalty for a short period of time. In other words, until I pay

Had net income and didn’t pay any taxes on W2 wages, that would be a different story – the IRS would charge penalties (technically, they charge you interest to reflect the time value of the money you owe them).

– this tax is collected throughout the year, not in April. (So ​​your employer withholds taxes from your paycheck and sends it to the IRS for you.)

It is worth noting that I am not a tax expert, so please consult a professional tax advisor if you need help understanding this for your situation and are not confident in doing the research on your own. I know not everyone spends as much free time on IRS.gov as I do.

How To Calculate Self Employment Taxes

Typically, the rule of thumb I hear is to set aside 30% of your self-employed income each month and let it sit in a savings account, waiting for the hard blow of your quarterly tax bill to fall on the guillotine. – inspired a reign of terror.

Let’s take an example to understand what I mean. I know self-employment income varies from month to month, but let’s simplify this example and say you’re self-employed making $10,000 a month (gross income).

For example, let’s say you also have a full-time job (like me!) that involves paying taxes on your W2 paychecks. Let’s say you earn $80,000 from this job.

If you set aside $3,000 of your self-employment income per month (30%), you’ll end up saving about $36,000 over the year (although after 1 year of self-employment, you’ll pay it in quarterly taxes to avoid underpayment).

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Because remember, right now, we’re only setting aside 30% of our income, assuming we’ll owe taxes.

Again, this example may be ridiculous, but I have a growing network of friends who work full-time and run side businesses – it’s less than you’d think, even if you consider the numbers I used for example. I use it, it’s funny. (round numbers, baby).

This example really blew my mind and it made me realize an amazing truth about calculating tax liabilities:

Basically, you should think of your “FICA” tax (Social Security + Medicare) entirely separate from your federal income tax, because FICA taxes apply to most of your income.

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When people talk about their “tax brackets,” they’re referring to federal income taxes, but the way your FICA taxes are calculated works a little differently.

Calculating federal taxes was difficult, but that was before I was introduced to the hairy and nasty world of FICA taxes. Enter.

(If you’ve ever looked at your paycheck, you’ll see “federal tax,” “social security tax,” and “medicare tax” as separate lines that break down your net pay.)

I do this by hand (using tax forms and Excel; not on paper, you pilgrim) to avoid the general black box nature of tax calculators.

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Don’t worry, I’ll show you my work. For simplicity, let’s use one of the 50 amazing states that have no state income tax. This means we only look at federal and FICA taxes.

So the first interesting thing to consider with part-time employment is that you are now liable for your own employment taxes.

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This “outstanding 30% rule” comes from the fact that self-employment income is taxed at 15.3% to ensure that self-employed people still pay Medicare and Social Security taxes.

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It’s worth noting that if you have more than $142,800 in W2 wages, you’re over the wage limit and you don’t have to pay the 12.4% Social Security tax on your self-employment income.

If you’re wondering, “Where did the 15.3% come from?”, you might notice that the “FICA” line is double the 7.65% charge. W2 employers are responsible for paying half of their FICA taxes. When you’re self-employed, you’re both an employer and an employee, henny — which means you’re on the hook for the entire 15.3%.

Economically, you will likely be offered a 7.65% lower salary because your employer knows they have to cover half of the FICA.

Because the IRS likes to make things difficult, it’s not as easy as 15.3% of your net income. It would be very easy. The actual calculation is as follows:

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. This honestly gave me a headache, so the tax form (Schedule SE – Self-Employment Tax) explains:

Since this form was for 2020, the salary limit was $137,700; in 2021, the upper limit is $142,800. This is one of the few taxes you actually pay

To figure out how much you owe, the IRS basically looks at the difference between your W2 wages already taxed for FICA ($80,000) and the $142,800 Social Security upper limit and Social Security payments from self-employment income, which is between ($62,800) corresponds.

Our hypothetical friend’s tax deduction per form is $5,473.71. This is considered his “employer’s” portion of Social Security and Medicare.

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Another benefit of self-employment income is that you may qualify for a nice 20% deduction (lowering your taxable income) called the Qualified Business Income Deduction.

Most small business owners with taxable income of less than $164,900 (single) or $329,800 (married filing jointly) qualify for a 20% direct deduction on their net business income.

You deduct all your expenses and deductions, including any contributions to pre-tax retirement accounts like a SEP IRA or Solo 401(k), but more on that later.

For example, our friend in this example made $120,000 in self-employment income. He incurred $2,000 in business expenses during the year and wants to deduct the portion of his self-employment tax that is legally allowed ($5,473.71).

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This is the amount of self-employment income he would have to pay tax on if he did nothing to reduce his taxable income.

Income of $200,000 between jobs, after taking the standard deduction for singles ($12,550), her business expense deduction ($2,000), and half her self-employment tax deduction ($5,473.71), her total taxable income is reduced to $179,976.29.

Do you remember? There is an income limit, and technically, she’s over it, but not by much. He is only for a

We definitely want to get the full QBI deduction because that means we can get 20% of our net business income off our federal taxes. Let’s see what we can do.

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To calculate her federal income tax, I basically ran the entire $200,000 of income ($80,000 from the W2 and $120,000 from the 1099) through the US progressive tax system to determine how much of her income falls under each tax bracket. subtracted his deductions (standard deduction for singles, business expenses, and ½ self-employment tax deduction). FICA (Social Security + Medicare)

We already know how much she owes in her self-employment income because we used Schedule SE to calculate it: $10,947.42. That’s a pretty big chunk, considering she needs to have the money ready at tax time to pay the bill.

Now, the real question mark is federal taxes – we know that federal taxes were deducted from her wages on her W2, but what does she owe on her self-employment income?

The US uses a progressive tax system, which means you pay no federal income tax on the first $12,550 of income (known as the “standard deduction” and to avoid tax on Roth conversions later in life) and then you pay an increased amount

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