If you work for yourself, it doesn’t take you long to figure out that the American Dream has a few strings attached. One aspect of self-employment that people hardly ever talk about is the self-employment tax. Yes, you already pay income taxes, and depending on how you structure your business, you may be paying them quarterly.
But what about FICA? It’s not the government’s job to make sure that you, as a self-employed individual, are paying the proper amount into Social Security and Medicare.
That’s part of your job.
This is what we mean by the self-employment tax. According to the IRS , the self-employment tax “is a tax consisting of Social Security and Medicare taxes primarily who work for themselves.”
The first thing to remember that unless you make more than $400 in a year, you’re not required to pay the any self-employment taxes. You’ll notice that the threshold for requiring to pay is lower than the amount required for a client to provide you a 1099.
You’ll also notice that there are two options for figuring your earnings to base your tax payment on: one for farmers and one for other kinds of self-employed individuals (the nonfarm optional method). The nonfarm optional method can be used if net profits are less than $5,457 and also less than 72.189% of gross nonfarm income, but you had net earnings from self-employment of at least $400 in two of the prior three years.
Please keep in mind, however, that the nonfarm income optional method can only be used five times by a self-employed individual.
When determining your income, make sure to clearly delineate between what you’re paid as a self-employed individual and any money you earn as the result of investing in something else – especially if the business you end up investing in is in a similar line to what you do. You also need to be aware of the IRS and court rulings regarding monies paid out as retirement. Retirement is just taxable income (depending if from a tax-deferred vehicle) not self-employment, and no FICA or medicare is taken out, just income tax based on your tax bracket.
Even if you’re not bringing in a lot of money yet as a self-employed trailblazer, you may want to consider going ahead and paying some self-employment tax voluntarily. Although you may not be legally required to pay, there is an advantage. You will be able to earn Social Security credits, which translate into higher benefit when you retire.