When you work for someone else, you can rely on your employer to withhold the proper amount of taxes from each paycheck and send that money to the IRS. But when you work for yourself, you do not have that luxury, and tax planning shifts from being a one-time burden to an ongoing strategy. If you are self-employed, you need to hold money back to pay your tax bill each time you receive payment from a client.
Social Security Taxes
Self-employed individuals are required to pay both the employer and the employee share of the payroll tax that funds the Social Security program. Normally the tax rate for both the employer and employee is 6.2 percent, for a total tax rate of 12.4 percent. But for 2011 only, the employee share has been lowered to 4.2 percent, making the total self-employed Social Security tax 10.4 percent.
When you work for yourself, you must pay both the employer and the employee share of the tax that funds the Medicare program for the disabled and the elderly. For 2011, the total Medicare tax is 2.9 percent, which represents a 1.45 percent tax for the employer and another 1.45 percent tax for the employee.
Federal Income Taxes
In addition to the extra Social Security and Medicare taxes, you are required to pay federal income taxes on the amount you make. The percentage varies depending on your total income, with taxpayers in higher income brackets paying a higher percentage of their earnings than those who make less. You can estimate your tax burden by using a tax preparation software package or by working with a CPA. If you expect to owe more than $1,000 in total taxes, you might be required to pay what you owe on a quarterly basis instead of filing just once a year.
Unless you live in one of the handful of states that does not impose an income tax, your state treasury will want a part of your self-employment earnings as well. The tax rate varies from state to state, so you will need to check with your state's revenue department to see how much you should hold back for state taxes. In some states you are required to file on a quarterly basis, just like you do with your federal taxes. In other states you can file once a year, just as you would if you worked as an employee.
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