The Five Business Taxes Every Self-Employed Individual Should Know

Bye, bye 9-5 and hello entrepreneurship! Yes, the full ownership of being self-employed kicks into gear once you are responsible for calculating, withholding and paying the tax liability assessed against your self-employed earnings. When it comes to paying taxes the IRS holds the taxpayer liable for their tax obligation, not the CPA or the bookkeeper. So, let’s explore the top five business taxes every self-employed individual should be informed about.  

  • Self Employment Tax – 

Now, that you are self-employed you are required by the IRS to adhere to the Self-Employment Contribution Act (SECA). Since 1954, this tax levy has forced self-employed individuals to pay into the social security program based on their net self-employment earnings. In case you are wondering, the IRS defines self-employed as someone who carries on a trade or business as a sole-proprietorship, an independent contractor, a member of a partnership or anyone who is otherwise in business for themselves (including part-time). 

As Self-Employment tax is Social Security and Medicare tax primarily for individuals who work for themselves, it’s not an exclusive tax imposed on self-employed individuals. Most wage earnings are also responsible for making contributions to the social security program, but the tax figure is shared between the employee and the employer. Whereas, the self-employed taxpayer is solely responsible to pay the employee and employer portion of the Federal Insurance Contribution Act (FICA) tax. 

The current self-employment tax rate is 15.3%. This rate consists of 12.4% for social security and 2.9% for Medicare. Net earnings that are subject to self-employment tax are figured using Schedule SE. Self-employed taxpayers must submit Schedule SEs with their annual Federal Income Tax return.

  • Federal Income Tax – 

Often abbreviated as FIT, Federal Income Tax is a tax imposed at the federal government level on net earnings received by income earning individuals. Enacted in 1913, the federal income tax has been described by the IRS as a pay-as-you-go tax. Meaning you must pay the tax as you earn or receive income during the year. 

The guideline to pay FIT as you earn income applies to both self-employed individuals as well as wage earners. However, as before, it is the self-employed taxpayer’s responsibility to calculate, withhold and pay federal income taxes. 

As the federal income tax system is progressive, the rate of taxation increases as income increases. Therefore, federal income taxes are calculated based on tax rates that range from 10% to 37%. Self-Employed individuals are required to report the business net income earned and pay the applicable FIT using Form 1040 Schedule C during the annual tax filing period. 

  • Estimated Quarterly Tax – 

Calculating, withholding and paying Estimated Quarterly Taxes as a self-employed individual is the most important tax obligation when it comes to preventing costly IRS fines and penalties. As mentioned above, the self-employment tax and federal income tax must be filed annually during the tax filing period. The estimated quarterly tax allows self-employed individuals who expect to owe $1,000 or more when filing their annual return pay the tax due quarterly throughout the year based on the projected self-employment and federal income tax liability.  

With this said, self-employed taxpayers, must be sure that they have covered their tax liability for the year to avoid any underpayment penalties. Again, as the self-employed individual, you have to figure your own estimated tax liability. Or, if you have a CPA or Tax Advisor on your team, you can seek their expertise. Nevertheless, it is still your responsibility to make sure this task is completed. Of my ten years of experience in the tax industry, I’ve serviced many entrepreneurs whose businesses suffered financially because of IRS penalties and fees due to the underpayment of taxes. 

How do you figure your estimated tax? When figuring your estimated tax you must figure your expected gross income, taxable income, taxes, deductions and credits for the year. It is best to use your prior’s years business tax return as a guide and Form 1040ES when you figure your estimated tax. For estimated tax purposes, the year is divided into four payment periods which are the month of April, July, September, and January. As you evaluate your business financials throughout the year, you will want to monitor your year-to-date estimated taxes paid to determine if you need to increase or reduce the remaining quarterly estimated taxes due. 

  • Employment Tax – 

As your business grows, you will need to eventually hire help to sustain the impact of growth. Well, once you reach this level of self-employment, you’re no longer responsible for just your self-employed earnings taxes you are also responsible for calculating, withholding and paying the FICA tax and FIT due from your employee’s income. 

As a self-employed taxpayer with employees, your tax liability increases to include other taxes such as unemployment taxes. Only the employer pays the FUTA tax. It is not withheld from the employee’s wages. Employers report FUTA taxes by filing Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return. Other forms that must be filed quarterly, semi-annually or annually by employers include Form 941, Form 944 and Form W-2. 

Employers that fail to deposit and report employment taxes by the Employment Tax due dates are subject to a failure-to-deposit fee up to 15 percent.  

  • State and Local Tax – 

Self-employed individuals State and Local tax obligations will vary depending on the business location. If your business is located in a state without income tax such as Texas, Nevada, Wyoming, Florida or Alaska, there could be other state and local taxes imposed. States without income taxes typically rely heavily on sales tax, excise tax and/or property taxes to fund state infrastructure and services. 

As with the previous four business taxes, the state and local taxes are also the sole responsibility of the self-employed individual to calculate, withhold and pay the applicable taxes due. When determining your State and Local taxes responsibility seek guidance from your local Secretary of State or Tax Professional. 

Your basic understanding of these five business taxes will help you stay compliant with your tax obligations as a self-employed individual. As you do your own homework and research your tax obligation, take advantage of the irs.gov website. There you will find all IRS Publications and Forms applicable to your business venture.  Receive additional informative tax information when you subscribe to receive our newsletter.