Self Employment - How Much to Hold Back?

Question

I see that self employment tax is 15.3% .. is that how much (or maybe 20%) I should hold out of my check in order to pay taxes?? I've seen people suggest holding back as much as 30% of your earnings ... why so much if the self employment tax is only 15.3%??

Answer 1

In general, I would recommend putting between 30-40% of your net income (pre-draw) aside for taxes...using the following breakdown:

15 - 15% Self employment
10 - 20% Federal Income Tax
3 - 5% State Income Tax

Remember that the self-employment tax (and income taxes) will be based on your net income. By Net Income, I mean your cash receipts for the year (assuming you are a cash based taxpayer/business, as opposed to an accrual based business), less your cash disbursements for business purposes (this does NOT include your draws, or what you pay to yourself.)

Another factor to consider is will you be employed at any time during the year. If so, this may reduce your self-employment tax liability, depending on how much you make at the other job, and how much you make as one who is self employed.

How much you will make in a year (again, before you pay yourself) will affect your tax liability. For example, if you net 200k in your business, you will pay less than 15.3% in Self employment tax (since a large portion caps out around 100k. In 2006, you are taxed @ 15.3% for the first $94,200 of net income, and 2.9% on anything above that for Self-Employment). On the flip side, you will pay significantly more in income tax, since you would be in a higher bracket.

Other sources of taxable income (interest, dividends, rentals, etc) will increase your income tax rate (but not your self-employment tax rate)

You may want to prepare a budget of what you expect to collect and pay out for business purposes and work with a tax professional to get a more accruate estimate of what you should put aside for tax purposes

Answer 2

You pay extra because if you were a W-2 employee, you would have paid 7.65% of your pay everyweek through social security/medicare withholdings, and your employer would have paid an equal amount. Since you are a 1099 employee, you pay the employer's share (since you are self employed). One half of the self-employment tax would have been paid by you through payroll deduction if you were a W-2 employee, so that is more a case of pay the same but just pay it later. The only ways to reduce the self-employment tax are: 1. Make sure you take every business deduction you can to reduce your net business income. 2. Put money into a self-employed 401k/IRA plan through Vanguard, Sharebuilder, or other such investment website. You can put up to 20% of your net profits into such a plan and avoid paying self-employed ss and income taxes on them (or at least defer them until distribution when you retire). 3. Work for a company with regular earnings as a side job where your combined income from the side job and your business is greater than $106,800. The ss tax stops at $106,800 in earnings. Medicare continues on after that amount. 4. If you had a helper/subcontractor, give them a 1099 for the money you upaid to them and take that as a business expense deduction. The one good thing about self-employment is that it is considered earned income for purposes of the earned income credit, so if you have a child, you will probably qualify for the earned income credit to offset some of this tax. If you are still working as a 1099 employee this year, you should sign up to pay quarterly estimated taxes of at least $1,000 a quarter so that you are not caught with a big bill next year.

Answer 3

You still have regular income tax, and state tax on top of the self-employment tax. That's why people suggest holding back 30% (or more of your earnings).

Answer 4

The self-employment tax is just for social security and medicare - any income tax you owe is in addition to that. Depending on what you make and your personal situation, that could be quite a bit more.

Answer 5

The 15.3% only covers the self-employment tax (social security and medicare). On top of that you need to pay Federal Income Taxes (10%-35% depending on your income) and State Income Taxes (varies).

Answer 6

The "self employment tax" is the employer portion of the FICA tax. You still will have to pay income tax on your earnings.