If you work for yourself, you don't have an employer to withhold taxes from your paycheck. You have to pay them yourself, including self-employment tax. For example, if you're a freelancer and you receive 1099 forms at the end of the year, nobody is withholding taxes for you. You have to do it yourself for income tax and self-employment tax.
Self-employment tax includes Social Security and Medicare. Everyone who earns money is required to pay this tax. If you don't pay into the system, you won't receive any of these benefits.
As a self-employed individual, you will pay more than your employed counterparts. At least that is how it will look. Social Security and Medicare taxes are paid at the same rate for every individual. However, when you are employed, your employer pays half and you pay the other half. If you're self-employed, you are both the employee and the employer, so you have to pay both.
This tax is made up of Social Security at 10.4% and Medicare at 2.9%. If you make more than $106,800 in a year, anything over that amount is not subject to Social Security tax, only Medicare tax. These numbers are for the tax year 2011 and may change from year to year.
The best plan of action is to pay your taxes, self-employment and regular income taxes, through quarterly estimated payments. If you make over a certain amount and you don't pay these taxes quarterly, you will be charged a tax penalty. In other words, pay your taxes throughout the year if you want to save money.
These are estimated tax payments. That means when tax season comes, you will file taxes just like everyone else. The money you paid as estimated payments may cover most or all of what you owe, or you may have paid too much. You will need to find the right form for estimated payments depending on what type of business you have such as a sole proprietorship or a partnership. These forms can be found at the IRS website, www.irs.gov.
When it comes time to file your taxes, the Schedule S is used to file self-employment taxes. If you are using tax software, you won't need to worry about this. As you fill in your 1099 information, the software will guide you. Otherwise you can use the printed tax form and fill it out yourself. It is not a complicated form to fill out.
One benefit that is available to you as a self-employed individual is that half of your self-employment tax is tax deductible. Basically, it puts you on even ground with employees who don't pay taxes on what their employer pays as part of their Social Security and Medicare taxes. In other words, you will ultimately pay the same amount as employees.
There are many tax benefits to being self-employed such as deducting business expenses, but you still have to pay Social Security and Medicare taxes just like everyone else. The difference is that you pay it in a different way. Always remember to pay your taxes on time to avoid penalties.