If you’re a self-employed individual, paying taxes on your income is a little different than if you were employed by someone else. When you’re self-employed, you’re responsible for filing your own tax returns, and so you should have a better understanding of tax codes than most.
For example, there are some great tax deductions made possible for self-employed individuals in 2022, but there are also some changes made that can hurt your bottom line if you don’t know how to navigate them.
With that said, let’s look at the most important things you should know about self-employment tax for the current tax year.
What Is Self-Employment Tax and Who Does It Apply To?
At a basic level, self-employment tax, or FICA, comprises of Social Security and Medicare tax, but you’re responsible for paying it out on your own, rather than having it automatically calculated by an employer to be deducted from a paycheck.
How Much Is the Self-Employment Tax?
Self-employment tax is a set rate of 15.3% of your net earnings, which consists of 12.4% for social security, and 2.9% for Medicare. Your net earnings are defined as your salary minus any deductions.
The reason it’s 15.3% is because self-employed individuals are paying FICA for both the employer and employee portions of the tax. It works this way – when you have an employer, you are technically paying 6.2% on social security, and 1.45% on Medicare. The employer is legally required to match these contributions, the IRS gets an additional 6.2% and 1.5% from your employer, for a combined total of 15.3%.
Now because there’s no middleman (employer) for self-employed individuals, the IRS just takes the entire 15.3% from you.
Employees who earn more than $142,800 are exempt from the social security tax, and so an employer would be exempt from sharing that tax as well.
How Can I Reduce the Self-Employment Tax?
Here’s the trick – you can’t lower the 15.3% portion of the self-employment tax, but because it’s taken from your net income after eligible deductions, you can utilize as many business deductions as you’re eligible for to lower your tax liability.
For example, let’s say you’re a graphic designer who’s earned $100,000 in 2021. And you take $15,000 in business deductions, leaving you with $85,000 in net earnings. Thus, you’ll need to pay $13,005 in self-employment tax.
Now, this seems like a huge amount all at once – which is why most people make a quarterly estimated tax payment instead of a yearly one. And in fact, the IRS will penalize you if you don’t pay quarterly and you’re on track to owing more than $1,000 in taxes.
However, this does show that it’s in your best interest to take as many deductions as possible, so you can reduce your self-employment tax liability.
Useful Self-Employed Business Deductions in 2022
There are many different tax deductions that a self-employed business owner can take, but let’s look at some of the most useful ones in terms of lowering your tax liability.
Home Office Deductions
If you work from home, whether you’re renting or paying a mortgage, you can deduct a percentage of your home expenses including a portion of your rent or mortgage, maintenance, and property taxes.
You have two options here. You can calculate the percentage of square footage used exclusively for business purposes, and deduct a percentage of that percentage. For example, if your home office takes up 10% of your home in square footage, then you can take 10% of housing expenses as a business deduction.
Or, you can use the simplified option of deducting $5 per square foot of your home office, up to 300 square feet. This would amount to a maximum $1,500 deduction.
Deducting Self-Employment Tax Itself
This is a pretty common deductible for self-employed individuals. Essentially, you can deduct half of your self-employment tax from your income taxes. So let’s say you owe $4,000 in self-employment tax, but you can deduct $2,000 on your Form 1040.
Business Travel and Meals
The IRS decided to be unusually generous in IRS Publication 463, and in 2021 and 2022, allows up to 100% of meal costs to be deducted, if they were actually business-related meals.
Previously, you could only deduct up to 50% – so if you do a lot of client-wooing at restaurants, be sure to save your receipts. Alternatively, you can use a standard daily meal allowance, which allows you to deduct a flat amount rather than hoarding receipts.
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