For some people, taxes are a once-a-year matter, but for employers and some employees the discussion is often much more complex. Employees must make choices that help determine the amount of their taxable income and withholdings. Federal and state income taxes, Medicare and Social Security taxes, and paying unemployment taxes are just a few of the considerations for companies of any size. Estimated taxes, deductions and depreciation are issues a self-employed person may need to understand.
Withholding TaxesThe people who are on the company’s payroll are subject to a number of taxes the employer is responsible for withholding. These are paid based on the rate or amount of an employee’s wages, salary and commission.
An employee must fill out a Form W-4 designating the filing status, such as single or married filing jointly. The form also includes information about employee allowances claimed, which may be taxable or tax-free. These and other factors affect how much the employer will withhold. At the end of the year, the employee receives a Form W2 from the employer that details the annual wages and the amount of taxes that were withheld from her or him.
Medicare taxes are figured based on a percentage of the earnings. The employee withholdings are 1.45 percent of the wages, and the employer matches that amount. Similarly, Social Security taxes are matched, with 6.2 percent of the taxable wages withheld from the employee and the same amount paid by the employer.
Unemployment TaxesThe Federal Unemployment Tax Act requires employers to pay unemployment taxes for each employee. These are used as a type of safety net, providing compensation when people lose their jobs. There are also state unemployment systems that require most employers to pay a second unemployment tax. Neither of these are deducted from employee paychecks. The federal unemployment tax of six percent is imposed on an employee’s first $7,000 in earnings. The amount paid on state unemployment taxes may count as a tax credit.
Independent Contractors vs. EmployeesThe employer is not responsible for paying taxes if the person who performs the labor is hired as an independent contractor rather than an employee. However, there are differences between the two, and an employer may invite legal trouble from the Internal Revenue Service if an employee is misclassified as an independent contractor.
Independent contractors are typically paid by the job, keep their own records and determine the best way to get the job done. Employers provide them with a Form 1099 that shows their earnings, and they use this to file their own taxes.
In contrast, an employer has control over the work an employee performs, and typically provides training so that it can be done to specifications. Work is performed while on the clock, and employees often receive paid leave or other benefits.
Self-Employment TaxesFor tax purposes, people are self-employed if they earn a profit from a business or skill but have not formed a corporation. Sole proprietorships, independent contractors and farmers are some examples of people who are self-employed. Since they must pay their own taxes and have no withholdings, most experts recommend they put back money regularly in preparation for paying the taxes owed on their earnings. According to the IRS, a person is not required to file a Schedule SE for self-employment tax if the net earnings are less than $400.
The Estimated Tax for Individuals form, or Form 1040-ES, provides instructions for determining how much of the earnings should be designated for tax purposes. Estimated taxes are paid quarterly, so in addition to April 15, self-employed people pay taxes on June 15, September 15 and January 15. It may seem as if there are more taxes paid because both the employer’s responsibility and the employee’s is being paid by the same person. However, after filing a 1040, some of that may be returned.
Deductions lower the amount of taxable income, and they may significantly lower the tax burden of someone who is self-employed. The entire amount paid on health insurance is a deduction, as are other types of insurance. Further expenses that may be deductions include legal services, advertising, rent and utilities, travel and mileage, mortgage interest, bad debts and many more.
Large purchase expenses, such as computers or vehicles that are expected to serve the business for more than one year, lose value over time. Rather than deducting the expense once, these items ‘“ known as capital assets ‘“ are valued over their determined lifetime, and then the amount is divided between the years and the result is used annually.
Proper documentation and payment of employment taxes is extremely important to prevent trouble with the IRS in the event of an audit.
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