Income and self-employment taxes are levied on individuals who earn money outside of traditional employment settings. Understanding why you might pay both taxes is necessary for anyone navigating the world of independent work.
By learning about the various scenarios in which these taxes apply, you can better manage your finances and ensure compliance with tax laws.
What is self-employment tax?
First, it is important to understand that this tax is different from income tax. Self-employment tax specifically covers Social Security and Medicare taxes for self-employed individuals, ensuring they contribute to these programs similarly to how employees do through payroll taxes. In general, it is payable for net earnings of more than $400 and, depending on your total income from all sources, you will pay both self-employment tax and regular income tax.
Working as an independent contractor
If you work as an independent contractor, you are typically considered self-employed. This means you are responsible for paying both income tax and self-employment tax on your earnings. Many jobs in fields like construction, freelance writing or graphic design are often classified as independent contractor positions.
Running your own business
When you run your own business, whether it is a small shop, an online store or a consulting firm, you are also responsible for paying income and self-employment tax. As an owner, need to report your business income and expenses on your tax return and pay taxes on any profits.
Freelancing
Freelancers and gig workers often earn income from multiple sources, such as writing articles, driving for ride-sharing services or delivering groceries. Regardless of the type of work, if you are self-employed and earn more than $400 in net income during the tax year, you will likely owe self-employment tax.
Selling goods or services
If you sell goods or services, whether it is through an online marketplace, at a craft fair or to friends and family, you may be subject to income and self-employment tax. Even if it is just a side hustle or hobby, any income you earn is generally taxable.
Investing in real estate
When you earn rental income from properties you own or operate as a landlord, you are also responsible for paying income tax on that rental income. Additionally, if you are actively involved in managing the properties, you may also owe self-employment tax on that income.
Understanding your tax obligations and properly reporting your income is key to avoiding penalties and ensuring compliance with tax laws.