Understanding and Calculating your tax liability – a simplified system

Taxes sure is a guarantee in life. When we are an employee, our employer will withhold and remit taxes to the government.

When we work for ourselves, we’re responsible for paying taxes on our income.

IRS defines self-employment tax as “a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.”

We’ll cover self-employment tax and income tax on this post – as those 2 are important to consider when dealing with your finances.

Who should be paying Self Employment taxes?

Anyone that has a side gig, works as an independent contractor or own their own business (as a single-member LLC, or partnership).

As a business owner, you’re responsible for 100% of the Medicare and Social Security taxes – this means a 15.3% of your net profit.

Let’s say your revenue was $50,000 for this year, and your business expenses were $10,000, your net profit would be $40,000

Net Profit = 50,000 – 10,000

You’d calculate Self Employment Tax based on the $40,000. In this case, your tax to be paid would be 40,000 x 15.3% = $6,120

Now… let’s talk income tax. This is a completely different beast. In the U.S.A., there are a few variables to consider when filing for taxes – how you file (single, married jointly, head of household, etc) and your income level. To know exactly what is your tax liability, I strongly recommend you working with a tax professional.

For your income tax, your net profit will also be the base of your tax calculations, and we’ll “deduct” half of the Self Employment tax. Still using the example above, the net income for your taxes will be:

$40,000 x [1-(0.153/2)] = $40,000 x (1-0.0765) = $40,000 x 0.9235 = $36,940

Let’s pretend the example above refers to a single woman. She files her taxes as “Single”

With a Net Profit of $40,000:

Self Employment Taxes: $6,120 ($40,000 x 15.3%)

Income Taxes: $4,238.80 ($970.00 + $3,268.80)

Taxable Net Income: (40,000 x 92.35%) = $36,940

$9,700 x 10% = $970.00

($36,940 – $9,700) x 12% = $27,240 x 12% = $3,268.80

This is a very simplistic way of dealing with taxations, we always recommend consulting with your tax professional for a more in depth analysis of your liabilities. There are additional deductions or even tax credits to be considered by a tax professional to lower your tax liability.

Disclaimer: This is considering Federal Taxes only – for state and local taxes, we recommend connecting with a tax professional.

When to pay your taxes?

You can remit quarterly tax payments – this helps with the burden of a big bill at the end of the year and avoid any penalties or fees. Your estimated taxes are based on your previous year’s income and your income during the quarter. Payments should be remitted:

Q1: April 15

Q2: July 15

Q3: October 15

Q4: January 15 (following year)

If you do not remit quarterly payments, your taxes will be due March 15 of the following year.

Conclusion

As President Benjamin Franklin once said, “In this world, nothing can be said to be certain, except death and taxes”. Planning for your tax liability will help you ensure that your business will be able to pay for its taxes.

As a rule of thumb, I recommend saving 25% to 30% of your revenue (sales) towards taxes. This is to be on the safer side and make sure you’ll be able to meet your financial obligations with the government.

Disclaimer: This is just a simple guideline of an overview of tax liabilities with the Federal Government. Some states and counties have their own tax liabilities. I recommend you connect with a tax professional to learn more about your tax obligations. To schedule a free consultation with me, click here.