CARL WATTS & ASSOCIATES

July 20, 2015

www.carlwatts.com
office@carlwatts.com
Washington DC
 tel/fax 202 350-9002
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For those of you with a taste for surveys results, here it is: self-employed people love their jobs more than anybody else. It is also true that “love” comes with certain “obligations” as well, and those tax related may weigh heavier than others.


But first, let’s see who the self-employed are, namely from the IRS point of view. The IRS say that, generally, you are self-employed if any of the following apply to you:
  • You carry on a trade or business as a sole proprietor or an independent contractor;
  • You are a member of a partnership that carries on a trade or business;

  • You are otherwise in business for yourself (including a part-time business).

As self-employed, you have to pay income tax just like anybody else, but you are also responsible for paying self-employment tax.

Before you can determine if you are subject to self-employment tax and income tax, you must figure your net profit or net loss from your business on Schedule C or C-EZ.

Self-employment tax (SE) is made up of Social Security and Medicare tax for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld from the pay of most wage earners.

It should be noted that anytime self-employment tax is mentioned, it only refers to Social Security and Medicare taxes and does not include any other taxes that self-employed individuals may be required to pay.


The self-employment tax rate, as well as the employment tax rate, is set by Congress and is subject to change. In the last few years, self-employment tax was set at 15.3% of gross earnings. The Social Security tax was set at 12.4% on the first $117,000 of net self-employment income, and the Medicare tax at 2.9% on all net self-employment income.

You must pay self-employment tax and file Schedule SE (Form 1040) if either of the following applies:
Your net earnings from self-employment (excluding church employee income) were $400 or more.

You had church employee income of $108.28 or more.

If you have earnings subject to self-employment tax, use Schedule SE to figure the tax due on your net earnings from self-employment. The Social Security Administration uses the information from Schedule SE to figure your benefits under the social security program. The self-employment tax rules apply no matter how old you are and even if you are already receiving Social Security or Medicare.

As everybody knows, half of the employment tax is paid by the employer and only the other half of the tax is deducted from the employee’s wages. It is only fair that, as self-employed, you are able to deduct part (50%) of your self-employment tax as an adjustment to income on the first page of your 1040 Form, Line 27.

If you completed Section A of Schedule SE, the deductible part of your self-employment tax is on line 6. If you completed Section B of Schedule SE, it is on line 13.

It is worth mentioning that special rules apply to workers who perform in-home services for elderly or disabled individuals (caregivers), to ministers and members or religious orders (but not church employees) , as well as to farmers.

Since there is no withholding of taxes for the self-employed, you need to make quarterly estimated payments to cover income tax and self-employment tax.
Adjustements to Income -
Self-Employment Deductions
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It is also important to remember that you may have to pay 0.9 percent additional Medicare tax if your income exceeds certain threshold amounts.

On the following Line of Form 1040, Line 28, the self-employed can deduct any retirement contributions made to SEP-IRA, SIMPLE-IRA, or Keogh-plan.

Self-employed persons have many of the same options to save for retirement on a tax-deferred basis as employees participating in company plans. Here is a short description of the retirement plans suitable for the self-employed.


With a Simplified Employee Pension (SEP) plan you can contribute as much as 25% of your net earnings from self-employment (not including contributions for yourself), up to $52,000 for 2014 ($53,000 for 2015).


You can establish the plan with a simple one-page form by completing Form 5305-SEP, Simplified Employee Pension - Individual Retirement Accounts Contribution Agreement, or an IRS-approved “prototype SEP plan” offered by many mutual funds, banks and other financial institutions, and by plan administration companies; and open a SEP-IRA through a bank or other financial institution.

With a 401(k) Plan you can contribute up to an additional 25% of your net earnings from self-employment for total contributions of $52,000 for 2014 ($53,000 for 2015), including salary deferrals.

With the SIMPLE IRA you can put all your net earnings from self-employment in the plan, up to $12,000 in 2014 and $12,500 in 2015 (plus an additional $2,500 in 2014 and $3,000 in 2015 if you're 50 or older) in salary reduction contributions and either a 2% fixed contribution or a 3% matching contribution.

Retirement plans for self-employed people were formerly referred to as “Keogh plans” after the law that first allowed unincorporated businesses to sponsor retirement plans. Since the law no longer distinguishes between corporate and other plan sponsors, the term is seldom used.

A third very important adjustment to income that self-employed persons are entitled to is the self-employed health insurance deduction.

Just as employees have their health insurance premiums excluded from their taxable income, if self-employed, you can deduct your health insurance as an adjustment to income on Line 29 (Form 1040).

The self-employed can deduct insurance premiums for medical insurance, dental insurance, or long-term care insurance for themselves, their spouses and dependents, as well as adult children to age 27 even if they are no longer dependents, all this as part of the self-employed health insurance deduction.

Self-employed persons who pay supplemental Medicare premiums (such as for Part B coverage) can deduct those supplemental premiums as part of the self-employed health insurance deduction.

Before claiming the self-employed health insurance deduction, you should calculate your allowable health insurance deduction. To do that, take your self-employment income and subtract the 50% deduction for self-employment taxes, and subtract any retirement contributions made to SEP-IRA, SIMPLE-IRA, or Keogh-plan.

If you are reporting a loss from your self-employed activity, then you are not eligible to deduct your health insurance costs since this particular deduction is limited by your self-employment income. You can however still claim the health insurance expenses as an itemized medical deduction.


Self-employed persons and small-business owners have to wear many hats, as they say, but when it comes to financial planning and taxes, that hat better be worn by a professional who can make sure that all fiscal obligations are met, and all deductions and credits available are taken advantage of.