You go to work every day, you contribute to society by paying taxes out of your paychecks on each payroll, but do you understand the full earning statement? Whether you are getting paid salary or hourly, you have to pay taxes, and that depends if you are running a business or working for someone else. When you run a business or are self-employed, you are responsible for the tax liability for the year you earn your income. Self-employed people have to pay self-employment taxes and employee taxes; in other words, you are liable to pay the employee and the employer part of Social Security and Medicare, known as FICA in your W-2.
Understanding all your deductions in your pay-stub is crucial. It can save you or lose you money. A rule of thumb to do every year is to adjust your W-2 withholding. Life happens, and things change, so you should be re-looking at your earnings every start of the year, especially if you get a nice raise or extra cash from that business you are running from home. Remember that extra money means that your tax liability goes up, and you want to prepare yourself for any tax owed.
How to avoid paying too much taxes if you just started your small business, but still have a regular job? While you are working, you can always adjust your W-4 to factor that extra increase in income you made from that side hustle business or gig you earn. Most people start a home business and are not aware of how much they will owe in tax liability. If you want to keep things separate from your W-4, one thing to keep in mind is to be able to make quarterly payments to reduce your tax liability for that year.
Your self-employed tax liability calculation is as follow:
Net income * (Social Security % for that year + Medicare % for that year) = Self-employment tax liability
For 2020 the total percentage is $15.3%. Also, remember that Social Security has a cap of $137,700 for this year. If you earn more than $137,700, you will have to adjust your calculations. Please email me or consult with your CPA.
In conclusion, if you are self-employed, you are also responsible for paying quarterly taxes, as I explained above, you are liable to pay Federal and State taxes for your side hustle extra income earned. I will write more about setting a business entity in my next post, and you will see why it is so crucial for your business to establish an entity. As always, thank you. Please email me or leave me a comment.