Do you have self-employment (SE) income from your main occupation or a sideline business? You may be in for an unpleasant tax surprise when you fill out your return and owe hundreds or thousands of unexpected dollars in SE tax. Ouch!
Strategy: Don’t pay a penny more than the amount required by law. Work through Schedule SE of Form 1040 carefully. Taxpayers often make mistakes on this complex form, especially if they have wages or salary income from other sources.
Here’s how it works: Self-employment tax is the equivalent of Social Security taxes paid by employees, but the tax rates for self-employed individuals are doubled. The Social Security portion of the tax is 6.2 percent for employees; 12.4 percent for self-employed individuals. For 2006, the Social Security tax applies to the first $94,200 of earnings. (This “wage base” increases to $97,500 for 2007.) The Medicare portion of the tax—1.45 percent for employees, 2.9 percent for self-employeds —applies to all earnings.
For instance, if all your wages come from self-employment income and you netted $100,000 in 2006, you must pay Social Security tax of $11,680.80 (12.4 percent of $94,200) and Medicare tax of $2,900 (2.9 percent of $100,000) for a grand total of $14,580.80 in SE tax.
Remember:You can use any Social Security tax paid as an employee to offset your SE tax bill on Form 1040-SE. It doesn’t matter that the SE tax rates are double the regular rates.
Similarly, a loss from a different self-employed business you operate can offset the SE tax you owe from your main occupation. But you can’t use your spouse’s Social Security tax or SE tax to offset your own liability. Each spouse must fill out a separate Schedule SE if both are self-employed.
Tip: You can deduct half of the self-employment tax you pay above-the-line on your Form 1040.
Example: Numbers don’t lie
Let’s say that the sideline business you started a few years back has grown into a major moneymaker. Now you earn $100,000 of SE income from the business in addition to the $90,000 salary you continue to pull down from a conventional job. You can use the Social Security tax paid from your salaried job to reduce your SE tax bill.
Because you’ve already paid Social Security tax on $90,000 of wages, you only have to pay the tax on $4,200 of SE income. The offset for Social Security tax paid on wages is a big help. For instance, if all of your $190,000 income in 2006 was SE income, you would owe a whopping $17,190.80 in SE tax ([$94,200 x 15.3 percent] plus [$95,800 x 2.9 percent]).
|Social Security Tax Portion||Medicare Tax Portion||Total|
|Combined Social Security tax||$6,100.80||$4,205||$10,305.80|
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