💯 💯 💯 "you're not just an employee, but the business owner as well. So naturally, you're going to be responsible for 100% of your Social Security and Medicare costs, as opposed to just fronting 50%."
EP 42: What is the self-employment tax? Do you know what it makes up the SE tax and how it the rate is calculated? Is it even important to know? In this episode, I'll discuss the basics of self-employment tax and why you should know it.
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Michael Der 0:02
You're listening to Artrepreneurs, a podcast that inspires photographers and visual artists to live their best creative lives. My name is Michael Der and I am a full time photographer with nearly 10 years of experience in the freelancing world. And I'm sitting down with an amazing community of visual artists to talk about process, business, and the lessons that have helped them grow. So let's get to it. Artrepreneurs starts right now.
All right, what is up everybody, welcome back to another episode of Artrepreneurs so appreciative to have you guys tuning into the show and supporting this content really means the world to me. Now today I'm going to talk about the self employment tax and what it really means for freelancers and solopreneurs. And while I've had several creatives on this show, who are actually creative employees, the main focus of the show is geared towards self employment. Now that's not to disparage any employees in any way. In fact, I'll continue to invite staff creators on the show down the road. At the end of the day, we're all trying to learn from each other, so there's no shade being thrown. Bottom line is if you can create and build a creative career, I salute you fully. But I did build a show around freelance and entrepreneurship life. And in that spirit, today's episode highlights one of the differences between employee life and self employed life, which revolves around self employment tax. So certainly not a sexy topic, but one that I think is very important.
Now, full disclaimer, I am not a certified tax professional Go figure. So any information that I do provide you should not be considered legal tax advice, anything that you need to have answered, you should be seeking out a true CPA that can help you understand your business, but also your state laws, as many of these states vary in income tax rates, while some don't even take it at all. So with that being said, let's dive right into self employment tax for freelancers and solopreneurs.
So what is self employment tax? And what is it for so the self employment tax or the S e tax for short, is a combination of two different taxes. One is Social Security, and two is Medicare. And so what these taxes are doing, are contributing to retirement benefits, disability benefits, survivorship benefits, and Medicare health insurance benefits. And for your edification, the tax rate breaks down as 12.4% for Social Security 2.9% for Medicare, which totals to 15.3% total. And at the time of this recording, this part of the tax applies to the first $137,700 of earnings.
So who pays self employment tax? Well, the long and short of it is everyone kind of does we all pay for it. Now not everyone's going to pay the full se tax because obviously, not everyone is self employed. But make no mistake, everyone basically pays for Social Security and Medicare in some form or another with a few unique exemptions. So even employees pay for it, they just don't pay as much. Now when you are a W two employee, your employer actually has to pay a portion of your taxes for you. They're going to match what you own Social Security and Medicare taxes much kind of like a retirement contribution. So basically, you're in agreement, whether you are aware of it or not to split that tax rate 5050 with your employer. Now it is understandable that because you're an employee, you may not be aware of this tax or any tax at all, because these taxes are actually taken out of your check automatically. That's what you call withholdings in America, payroll taxes are basically pay as you go system, meaning every time you get paid, the government gets their cut, too. So if I'm an employee, how much does social security and medicare cost me so if you're an employee, your paychecks are going to automatically withhold 6.2% of your gross wages for Social Security tax, while 1.45% of your gross wages will be withheld for Medicare tax that brings the total to 7.65%. Now, as I mentioned, that tax rate is 5050 split with your employer. So when you put in 7.65%, they will as well bringing the total to 15.3%, which exactly matches the self employment tax as I mentioned earlier, now if your brain is already a little scrambled, remember, as a W two employee, you already have this taken care of each and every time you get paid so you don't have to worry about it. There are no computations you have to do no financial wizardry you have to account for that is one of the main benefits of being an employee. You don't have to manage that tax. freelancers, on the other hand, do.
So why am I as a self employed person being taxed twice as much. And so in this regard, I totally understand that if you feel like being an employee is the bee's knees while being a self employed creative is probably the worst scenario possible because you're getting twice as much on the taxes. But that's only because you're not just an employee, but the business owner as well. So naturally, you're going to be responsible for 100% of your Social Security and Medicare costs, as opposed to just fronting 50%. So all owners with pass through income, which is going to apply to sole proprietors, LLC, s corpse, partnerships, and llps, you must pay the full se tax the full 15.3% of your gross income. And just in case any of those terms confuse you. If you don't remember registering as any one of those business structures by default, you actually fall under the structure of a sole proprietorship if you own and operate your business alone. So the bottom line is for self employed creatives because you are not only an employee, but also the boss as well. You owe the full 15.3% of your gross wages to self employment tax.
So what does this mean for me, as I mentioned before, one of the main benefits of being an employee is that all of this will be done for you. You get paid, the taxes are taken out pretty awesome right now. For the self employed, it is our responsibility to pay these taxes. Now what sucks, and there's no real way around this is that there's no email there, no knock on your door, no phone call saying, Hey, this is how much is owed. And here's the link to make your payment. And those are the cards that were dealt, folks. I mean, it's just part of the lifestyle of freelancing, we have to manage our income proactively so that we don't spend what is actually owed to taxes. And I can't emphasize this point enough. In fact, my first wake up call to full time freelancing, I had absolutely no direction, I was basically operating like an employee, I spent everything that I received on my paychecks to buy new gear to fund my business. And by tax time, I received a very rude wake up call that basically shook me to my core I owed over $10,000, to the IRS that I didn't have. And so this isn't Bs, folks, I'm not just saying this to sound like I know what I'm talking about, I actually really had to go through the hassle of filing an extension with the IRS, I had to set up payment plans, I had to incur a ton of interest in late penalties, it really took a couple years for me to get out of this hole. So safe to say is not a pleasant way to do taxes, folks, it's not a confidence builder as you start your business. So if you can't avoid the mistakes that I made, you're gonna save yourself a ton of money and a ton of stress.
So what should I do now to reiterate, folks, I am not a tax professional. I'm not suggesting that my way is the best way, by all means, if you consult with your own professionals, your financial planners, or your business coaches, or your tax professionals, somebody that knows your finances and knows your business more intimately, than listen to them and make the most informed decision that you can, all I can really say is, for me, the simplest solution has been to create a new savings account and label it taxes. And so what happens is, every time I receive a paycheck from a client, and I deposit it into my main bank account, I simply transfer the appropriate percentage to My Tax Account.
So let me give you an actual example here, I'm going to use the number $1,000. Because it's very easy to remember, let's say I receive a paycheck for $1,000 for a job that I've done. And keep in mind, this is gross income, meaning that it's the amount that I've received before taking taxes and deductions into account. So it's $1,000 gross. And so I'm going to take that $1,000, and I'm going to multiply it by the tax percentage that I owe, which in my situation comes to around 30% of my paychecks, which is a combination of self employment taxes that 15.3 plus federal income and California state, which is somewhere in the neighborhood of 12 to 14%. So typically speaking around 30% of my paycheck, I am putting aside into that tax bucket. And so if I use that $1,000 paycheck as a barometer here, and then I take that 30% off of that, that comes out to $300. So now that I've done that calculation, all I have to do is transfer that $300 from that main account into a separate account, which is labeled taxes, let's use another number to let that sink in, let's say do a smaller job for $400. Well, 30% of 400 is 120. So I'm transferring $120 into that tax account.
Now for your situation, it may be a little bit different. There's about nine states out there that don't have any income tax. So again, consult with a tax professional on what your situation is, to more accurately gauge what you should be setting aside. And it really is as easy as that folks, I've basically just taken the money that is dedicated towards taxes and put it aside for taxes. The rest of it I can just use towards food, groceries, whatever it might be. Now my job isn't done there. Of course, after all, it's just money sitting into an account. The next part of course is paying it in America is a pay as you go tax system for this exact reason. The government knows perfectly well that if they left it up to the individuals to properly manage and budget their income, they'd never actually get paid as consistently and accurately. That is why withholdings are in place for employees. Uncle Sam gets his cut the same day that you do now for the freelancers and solopreneurs out there just like myself, we have a different system that we have to abide by. We have deadlines to pay taxes at each quarter of the year. These are called quarterly estimates. So each quarter I'm going to be paying the IRS an estimated amount of my taxes owed directly through the IRS website.
Do I need to pay quarterly taxes if I only freelance part time? Alright, so I've talked about the responsibilities of employees and full time freelancers, but what about the hybrid creators? Maybe you have a job and you freelance on the side? Well, the IRS states that freelancers who expect to owe $1,000 or more in taxes, they are required to make quarterly payments because freelance income is not withheld by employers throughout the year.
Now folks, I am going to go in depth on how to calculate and how to pay quarterly tax payments in a future episode. If this feels a little bit overwhelming. Don't worry, that's an episode by itself. The main emphasis of this episode is that you are not just the employee, but you're also the employer. So what that means is you are responsible for paying 100% of the social security and the Medicare tax which as I've mentioned, amounts to 15.3% of your gross income. So as a simultaneous employee and employer, it is your responsibility to proactively pay said tax to the IRS. There are no automated withholdings. There's nobody to pass the buck to there's no accounting team on your payroll as a sole proprietor. In fact, you effectively are the accountant. So as much as that may dishearten you to hear folks as much as that might suck to have that additional responsibility on your plate, then be the breaks. And personally I am so grateful to have this responsibility because it has forced me to be proactive in my personal and professional finance. Had I stayed a full time employee. This is no exaggeration. I don't know if I can honestly say that I would have ever implemented a system like this by splitting my income habitually. I have grown my savings. I've reduced my spending and I've organized my professional Budget from my personal one. And so even though I wish I didn't learn the hard way, I'm very appreciative of the lesson all the same.
So I hope that information gives you a little bit more clarity on the confusion and self employment taxes, folks, I know it's difficult, but at the very least, I hope this inspires you to do some more research on your own state laws, and maybe even ask the important questions to true tech professionals that can really help you manage your back end business. I want to thank you all for tuning in. And if you enjoy this show, please give us a follow on Instagram at Artrepreneurspod and be sure to subscribe to our weekly episodes. Thank you again, everybody, all the best and have a great week.
Hey, everybody, this is Michael Der thank you so much for making it all the way to the end of the episode. I hope you'll follow tag and engage with us on our Instagram account at Artrepreneurspod. We've also launched our website Artrepreneurspod.com It is the central hub where you can sign up for our newsletter, read our blog posts, send us voicemails, and even access discounts from our amazing affiliates. It's also the perfect spot to shout out Artrepreneurs with what would be an immensely appreciated five star rating and review. And if you're feeling extra generous, you can even make a small donation that's really going to help accelerate the growth of this podcast. But no matter what you do, folks, I just want to say thank you so much for supporting this program. There are a lot of great photography podcasts out there, and I'm just grateful to have gained your trust even for take care of everyone. See you next week.
Transcribed by https://otter.ai