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Basics of the Self Employment Tax

July 19, 2017 | By More


self-employment-taxMost of us work for small or large businesses and receive a salary or wages. At the end of the year we receive a document called a “W2” which sums everything up enabling us to do our taxes.

When we look at our pay stubs we see that 7.65 % of our gross income is taken out for so called FICA (Federal Insurance Compensatory Act). There are two components to FICA, OASB (old age survivor benefits or Social Security) and Medicare. This 7.65 % is matched by our employer making the total contribution 15.30 % (SS=12.4%, Medicare=2.9%) and the employer also gets a deduction against “income tax” for the matching amount.

As a “self-employed” person you still have to pay this tax (now called Self-Employment (SE) Tax) and the IRS has developed a parallel system to equate it with the FICA as described above. Being self-employed, you are the “employee” and the “employer” and so the SE Tax is imposed at the full 15.30 %. This can be a rude awakening to a first year entrepreneur, however, as we will show, you do get the deduction, just like the big guys.

At this point, bear in mind that we are talking about two different taxes, self-employment tax and Income Tax. The self-employment tax is entered as “other taxes” on Form 1040, line 57. Please don’t get these two mixed up.

Notation used:
= Form 1040, line 27
[SE / 13] = Schedule SE, line 13
Using 2016 forms.

Example: W2 Employee works 52 weeks, 40 hours / week for 30.00 an hour.

  1. Gross pay (G) is 62,400.00. This is the amount on which we compute the SE tax
  2. Employee FICA is 4,773.60 (62,400.00 x .0765)
  3. Employer match is 4,773.60
  4. Total FICA is 9,547.20 or 15.30 %, (7.65 x 2)
  5. Employer gets deduction for 62,400.00 plus matching FICA 4,773.60, total is 67,173.60
  6. G (gross pay) plus .0765 G = employer’s deduction. Formula: 1.0765G = Deduction

Self Employed person has revenues of 624,432.00 and deductions of 557,268.40 = Schedule C net income 67,173.60.

  1. Net income is 67,173.60 (same as step 5) but on what amount do we compute the SE Tax?
  2. Using the formula (step 6) we need to find G (step 1). So, consider that the 67,173.60 represents G plus .0765G, to get to G we could divide 67,173.60 by 1.0765 = 62,400.00 — OR we could just multiply by .9235 (100 – 7.65 = 92.35) as on Schedule SE line 4a. NOTE: multiplying by .9235 does not give 62,400.00, it gives 62,034.82. We should multiply by .928936 (1/1.0765) this would result in 62,399.98 (close enough). But, to avoid the wrath of Erse (IRS), you must use .9235 as directed on the Schedule SE. [SE / 4a,4c, and 6]
  3. Self-employed person is both employer and employee so SE Tax is 15.30% (.1530) times 62,034.82 which is 9,491.33
  4. And self-employed person gets the deduction against “income tax” of 4,745.67 (9,491.33 / 2) which lowers AGI to 62,428.00 and reduces “income tax” by 1,186.50, [SE / 13, 1040 / 27].

For a more complete version of this including the above example shown on the Form 1040 and the Schedule SE please contact me.

Contributed by William Lamb – Enrolled Agent
William Lamb, EA is located in Berkeley, California. For more information or to contact William Lamb, visit http://www.bookkeepinghelp.com/business/72134-94702/william-lamb-ea/berkeley-ca

Article information should not be used exclusively to make legal, financial or tax decisions. Because laws and rules can change frequently, topics may not always be updated to reflect these changes or may not apply to your unique situation. It’s prudent to seek out the advice of a professional for your specific needs.

Category: Taxes

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