Since the federal government taxes only your taxable income instead of all of your income, qualifying to claim tax credits can help reduce or even eliminate any tax you owe. However, even though tax exemptions, deductions and tax credits can reduce a taxpayer’s total tax liability to zero, there are situations when you might still owe the government taxes.
Self-employment tax is comparable to the Social Security and Medicare taxes usually withheld from a wage earner’s pay. Individuals who work for themselves rather than an employer must figure their self-employment tax using Schedule SE Form 1040 when filing federal income tax. Net earnings of $400 or more are subject to self-employment tax. Use Schedule C or C-EZ to figure your net earnings from self-employment if you work as an independent contractor or are self-employed as the sole proprietor of a business. Even if you have no taxable income after exemptions and deductions, you may still owe self-employment tax if you did not pay enough estimated tax.
Estimated Tax Payments
If you are self-employed, you are required to use Form 1040-ES to figure and pay estimated tax for income you report on your federal tax return. Filing Form 1040-ES allows you to pay income tax, self-employment tax and other taxes. If you do not pay an adequate amount of tax when each quarterly installment payment comes due, you can be charged an underpayment penalty when you file your tax return even if no other tax liability is due. Form 1040-ES includes a worksheet you can use to calculate the amount of income you expect to earn. When figuring your estimated tax, take into account your adjusted gross income for the year, taxable income, deductions and credits.
Tax on Investment Income
The health care bill passed by Congress in March 2010 comes with a new tax to help pay for Social Security and Medicare. Beginning in 2013, taxpayers with adjusted gross incomes above the threshold amounts will pay a 3.8 percent tax on a portion of their net investment income. The threshold for a single taxpayer is $200,000 and $250,000 for married taxpayers. If earnings from investment income when added to your wages put you above the adjusted gross income threshold for your filing status, you will owe the 3.8 percent tax on the amount of investment income above the limit. For instance, a married couple who earn combined wages of $170,000 and have investment income of $100,000 will owe additional tax on the $20,000 above the $250,000 AGI threshold. Even if you reduce your taxable income to zero after deductions, you could still owe the Medicare tax on your net investment income.
Late Filing Penalty
Unless you request an extension of time to file your income tax return for the tax year after the filing deadline, or can show reasonable cause for filing your return late, the IRS will charge you a late filing penalty. What not all taxpayers know is that since the penalty for filing your tax return late is a percentage of the tax you owe, there is no late penalty if you don’t owe any tax. However, if you have a refund coming, you won’t get your money until you file your return.
- The Wall Street Journal; How the New Wealth Taxes Will Hit You; Laura Saunders; June 2010
- IRS; Self-Employment Tax; March 2011
- IRS; Estimated Taxes; January 2011
- IRS: Form 4868-Application for Automatic Extension of Time; 2010
- IRS. "What Is the Additional Medicare Tax?" Accessed Sept. 30, 2020.
- Executive Office of the President and U.S. Treasury Department. "The President's Plan to Help Middle-Class and Working Families to Get Ahead," Page 36. Accessed Sept. 30, 2020.
- IRS. "Topic No. 560 Additional Medicare Tax." Accessed Sept. 30, 2020.
- IRS. "Topic No. 751 Social Security and Medicare Withholding Rates." Accessed Sept. 30, 2020.
- IRS. "Questions and Answers for the Additional Medicare Tax." Accessed Sept. 30, 2020.
- IRS. "2019 Schedule SE (Form 1040 or 1040-SR)," Pages 1-2. Accessed Sept. 30, 2020.
- IRS. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Sept. 30, 2020.
- IRS. "2019 Form 8959." Accessed Sept. 30, 2020.
- IRS. "Questions and Answers on the Net Investment Income Tax." Accessed Sept. 30, 2020.
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.