A: “SE tax” is shorthand for “self-employment tax.” Paying SE tax is the way the government collects Social Security (also known as Old Age, Survivors and Disability Insurance, or OASDI) and Medicare taxes from self-employed individuals.
Most employees have the tax withheld from their regular paycheck and they can see the amounts on their paystubs and on the Form W-2 they receive each year. But for self-employed individuals, the tax is reported on Schedule SE, which is part of their annual individual tax return filing (Form 1040). While you report the tax once a year, you may actually be required to pay the tax in quarterly installments throughout the year.
For an employee, the Social Security tax rate is normally 12.4 percent of earnings up to a maximum of $110,100 (subject to an annual adjustment), and is shared equally by the employee and the employer. So 6.2 percent is withheld from the employee’s check, and the employer pays the other 6.2 percent. (For 2011 and 2012, the employee’s portion of the Social Security tax has been reduced to 4.2 percent due to special economic stimulus legislation.) The Medicare tax rate is 2.9 percent (with no salary cap) and is also shared equally by employee and employer.
Because a self-employed person is both employee and employer, those with self-employment income are required to pay the full amount of the tax, which is at a 15.3 percent rate (the 12.4 percent Social Security rate and 2.9 percent Medicare tax).
There is an allowable deduction for one-half of the SE tax in computing your income tax, but the important point here is that as a self-employed person, you do need to be aware of the tax that will be owed and report it properly on your return.
Finally, because your employer will not be withholding taxes from your paycheck, you will be responsible for paying the tax on a quarterly basis. Failure to make these payments in the right amount and at the right time can result in the assessment of penalties.
The basic rule is that you need to have 90 percent of the tax you owe for the year paid in four equal installments on the 15th of April, June, September and January of the following year. Of course, you may not know what your tax will be for the year when the first payment is due in April, and consequently the tax law does allow for methods to avoid the underpayment of estimated tax penalty. You should check with your tax return preparer to see which option is best for you.
To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation.
Peter Robbins is a partner in the Boise office of CliftonLarsonAllen, LLP specializing in tax matters for small businesses, individuals, and trusts and estates.
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