The Self Employment Tax Trap

Tax Defense Network writes: Unlike wage earners that work for employers and have their taxes withheld from their wages and deposited with the IRS, the self-employed have to calculate and pay their taxes themselves. Tax rules for the self-employed are different from those for businesses, individual taxpayers and those working for employers. Generally, self employed individuals are required to file a tax return if they earn $400 or more from self-employment.

Many times, misunderstanding IRS requirements or a lack of information causes the self-employed to underreport income and incur a tax debt. The tax rules that the self-employed must consider when calculating and paying their taxes are discussed below.

Self-Employment Tax

Self employed individuals are required to pay the self-employment tax in addition to federal income tax. Self Employment tax includes the self-employed individual’s Social Security and Medicare taxes. From 2013, an additional Medicare Tax of 0.9 percent was required to be paid by the self-employed. This additional Medicare Tax applies to wages, compensation, and self-employment income that is above a certain threshold.

Estimated Taxes

Self employed individuals may also be required to pay Estimated Quarterly Taxes. Estimated taxes include self-employment, income and any other tax a self employed individual may be required to pay and are paid at specific intervals throughout the year. Generally, if you expect to owe more than $1,000 in taxes by the end of the year, you should be filing estimated taxes.

Many times, self-employed individuals do not pay estimated taxes quarterly and wait for the traditional filing deadline of April 15^th. This leads to tax debt, as correctly paying estimated taxes every quarter is essential to remain compliant with the tax laws. The IRS even charges a penalty for underpayment of estimated tax.

Tax Credit and Deductions

There are many deductions that the self-employed can claim. Certain qualifying business expenses can be deducted from income to reduce taxes. The Home Office Deduction is often used by self-employed individuals who work from home.

Self-employed individuals can claim the Earned Income Tax Credit if they file Form 1040 Schedule C. This tax credit reduces the tax liability of those employed by an employer or work independently.

In order to avoid mistakes in calculating taxes and running the risk of a debt, it’s recommended to either seek the help of a tax professional or keep yourself up-to-date about the tax laws that impact you.