How does a person pay taxes and FICA in the United States when they become self employed?
No one in my family has ever been self employed. I apologize for this simple question which has probably been asked many times.
—Linda
How does a person pay taxes and FICA in the United States when they become self employed?
Fill out IRS Schedule C (as well as your regular Form 1040).
You may need to comply with your state income tax too.
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Lindytoes -
On your tax return, taxes for self-employment income are calculated in two parts: “self employment” tax on Schedule SE and “income tax” via Form 1040. Self-employment income is reported on Schedule C. It is recommended that self-employed individuals estimate in advance their total taxes and make timely and equal quarterly estimated tax payments throughout the year.
MakingTrax
Thank you for you replies. I’m at my daughter’s house and she’s going to be self employed soon. So I was able to tell her your replies right away.
—Linda
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How does a person pay taxes and FICA in the United States when they become self employed?
A self employed person will file schedule C to report their income and expenses from self-employment. That net income is used to figure up both income taxes and FICA taxes. FICA taxes are often referred to as the self-employment tax. Different names - same thing.
Both of those taxes are calculated and reported on your income tax return.
If the total of those two taxes is less than $1000, you can pay that with your return each year. But most self-employed people will need to pay estimated taxes 4 times during the year - on the 15th of April, June, September, and January (right after the end of the year).
Mechanically, you can pay those taxes via checks mailed to the IRS if you prefer. The IRS also has their Electronic Federal Tax Payment System (EFTPS) where you can make payments electronically. It does take a bit of set up, and they have some silly password rules. But the system is quite reliable, and allows you to schedule payments up to about a year in the future. It could take up to a month to get set up in EFTPS, so be sure to allow adequate time for that before your first payment is due.
–Peter
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Peter, if the person has both self-employment income and W-2 income, does the $1,000 limit apply to both of these taxes to determine estimated payments are required or not?
Linda,
My wife is self-employed (sole proprietor). Our tax forms include:
Schedule C: (this is where you report income and expenses). The net income on Schedule C is also entered on Schedule 1 (PT I, Line 3 Business Income). This then appears on Form 1040 Line 8.
Schedule SE: (this is the form where you calculate your self-employment tax liability). 50% of the tax liability also is entered on Schedule 1 (PT II, Line 15, Deductible part of self-employment tax). This eventually appears on Form 1040 on line 10.
Schedule 1 (PT II, Line 17): your daughter can take advantage of a self-employment health insurance deduction for health insurance premiums she pays (as long as it does not exceed net self-employment income).
Schedule 2 (PT II, Line 4): Enters the self-employment tax liability from Schedule SE.
Form 1040 (Line 23): This is where Schedule 2 appears on Form 1040. This is a “sneaky” part of self-employment filing because it is after any tax credits she might have that are entered on Schedule 3).
Her tax liability is $1350/yr and we pay $400/quarter in estimated taxes - more than we need to. Just being safe.
Hope this helps.
PW
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Hi Ken288 -
The IRS doesn’t care if your tax money comes in from paycheck withholdings or timely estimated payments, just as long as you get enough money sent in on time.
I have both a W2 paycheck and self-employment income, and I typically handle taxes via having sufficient money withheld from my W2 paycheck to keep me in a safe harbor limit.
The key is that there are three safe harbor tests. You need to be covered by one of them in order to avoid penalties when you file and pay any remaining taxes due by the standard April 15 deadline. This article has some more details: https://www.fool.com/investing/2020/12/12/5-tax-moves-to-mak… .
Regards,
-Chuck
Home Fool
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Peter, if the person has both self-employment income and W-2 income, does the $1,000 limit apply to both of these taxes to determine estimated payments are required or not?
Let’s back up a bit. The reason to make estimated tax payments is to avoid a penalty for underpaying your taxes during the year. Congress requires everyone to pay their taxes as they go during the year.
If you earn wages paid by an employer, you have taxes withheld from each paycheck. You are paying as you go. If you get monthly retirement benefits, taxes can be withheld from those benefits and you are paying as you go.
But if you don’t have these things - which is typical for a self-employed person - you need to pay as you go in a different way. That is done by making estimated tax payments.
If you don’t pay enough as you go through the year, you can be subject to the penalty for underpaying taxes. To be honest, that penalty isn’t severe - it’s basically interest at the prescribed interest rate (currently 4% or 5% a year - it changes quarterly based on market interest rates). But an avoidable expense is an avoidable expense, so it’s good to try to avoid this one.
So how do you avoid the underpayment penalty? There are three safe-harbors, three ways that mean you aren’t subject to the penalty. *** They are: 1. pay in 90% of your current year tax liability with a combination of withholding plus equal and on-time estimated tax payments, 2. pay in 100% (or 110% for higher incomes) of LAST years tax liability with that same combination of withholding and estimated tax payments, or 3. owe less than $1000 with your tax return after paying the rest with that combination of withholding and estimated tax payments.
What I was hinting at in my prior response is that if the self-employment is a small side hustle while working a full-time job, you can avoid estimates if the tax owed with the return is less than $1000 - that last option for avoiding the underpayment penalty. And as has been mentioned, you can increase the withholding from your wages to cover the taxes generated by that side hustle instead of paying estimates. Just get the withholding to the point that it covers one of those three safe-harbors by itself.
–Peter
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So how do you avoid the underpayment penalty? There are three safe-harbors, three ways that mean you aren’t subject to the penalty. *** They are: 1. pay in 90% of your current year tax liability with a combination of withholding plus equal and on-time estimated tax payments, 2. pay in 100% (or 110% for higher incomes) of LAST years tax liability with that same combination of withholding and estimated tax payments, or 3. owe less than $1000 with your tax return after paying the rest with that combination of withholding and estimated tax payments.
Also be aware that not all states have a safe harbor. For example, Pennsylvania does not. I always overestimated to be on the safe side.
HHP