 Income tax 2022-2023, self-employment SE tax. Let's do some wealth preservation with some tax preparation. Most of this information comes from the tax guide for small business for individuals who use Schedule C, Publication 334, tax year 2022. You can find at the IRS website, irs.gov, irs.gov. Looking at the income tax formula, we're focused on line one, that being income. Remember, in the first half of the income tax formula is in essence an income statement, although it's just the scaffolding, just the outline, meaning other forms and schedules will be feeding into it. For example, the Schedule C, our point of major focus here, support accounting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course, each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources, such as Excel practice problems, PDF files and more, like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. We'll feed into line one, that being income. The Schedule C basically being an income statement in and of itself with income minus expenses, basically business deductions, the net income flowing here to line one of the income tax formula. This is the first page of the Form 1040, we're focused on line number eight, which would have been populated from the Schedule C that flowed through to the Schedule One that flowed through the first page of the 1040 and line eight. This is the Schedule C profit or loss from business, basically an income statement, income minus expenses. We're now focused on the self-employment or SE tax, SE or self-employment tax is a social security and Medicare tax primarily for individuals who work for themselves. You might be asking, hey, look, I thought we were dealing with the Form 1040 and the federal income tax, what's this self-employment tax business? So let's take a step back and think about where we typically think of social security and Medicare taxes, that being as withholdings in a W-2 type of situation because the self-employment tax is basically mirrored off of that type of scenario. So if you were an employee working for an employer, we would call those payroll taxes. The payroll taxes, the amount that's withheld from your paycheck as a W-2 employee include the federal income tax, which we do deal with on the Form 1040, but also the social security and Medicare taxes. We see those on the Form W-2, but we often don't have to deal with them on the Form 1040 unless there's a problem because they've already been taken care of by our employer and the W-2 is kind of just an information form. For us, we're gonna use that W-2 primarily in that case to report the federal income tax and the overpayment of it, hopefully to get a refund from it. The way the social security and Medicare is set up is that if you had employee, employer situation, you would be paying half of it that would be taken directly out of your paycheck and the employer would also be paying half of it. So you have an employee and an employer half. Now, if you're self-employed, the IRS would like to say no, we don't want you to get away with not having to pay the social security and Medicare because now you don't have the payroll taxes and you're not giving yourself a W-2. They would most likely frame it this way. We want you to be able to participate in paying into the social security system so that you can get benefits in retirement age. But obviously, if you can not participate and keep your money and pay for your own retirement, you probably would be better off. But in any case, the IRS wants you to be paying into the social security, social security card and Medicare system. So they are in essence gonna take your Schedule C, look at the net income on that Schedule C and then charge you the equivalent of payroll taxes and in essence, both the employee and employer portion. So you're paying a larger amount of payroll taxes as a sole proprietorship business than you were if you were a employee because in an employee situation, you would only be paying the employee half. The employer would be paying the other half. So that's kind of one of the downsides of being a sole proprietor, contractor, you having your own business versus being an employee. However, on the plus side, you get the deduction. So you might be able to have deductions lowering the amount of income, which would lower the amount of self-employment tax. So that's the general overview that we're trying to kind of keep in mind. That means that we have to kind of report this and add that tax to the reporting on our Form 1040, something we're not used to doing if we normally had or prior had a W-2 type of situation. Okay, it is similar to the so-called Social Security Medicare taxes withheld from the pay of other wage earners. So caution, if you earn income as a statutory employee, you do not pay SE self-employment tax on that income. Social Security and Medicare tax should have already been withheld from those wages. Social Security coverage. Now note, when you're thinking about what type of income something is, this becomes important because now the question is, is the income that you have subject to self-employment tax? So obviously if you had a W-2 employee, that income from the W-2 is not subject to self-employment tax because you already paid, in essence, your portion of the equivalent of payroll taxes. If you have self-employment business, then you're reporting on a Schedule C, that's the primary example of something that would be subject to self-employment tax. If you've got other kinds of income, like hobby income or something like that, then you may not be subject to the self-employment tax. That's a big deal because the self-employment tax can be substantial. All right, Social Security coverage. Social Security benefits are available to self-employed persons just as they are to wage earners. Notice what the IRS focus is in on here, and I just wanna point out the perspective when you're talking with the IRS because obviously they're gonna come from the perspective that all this stuff is just for your own benefit, right? They're forcing you to pay into the Social Security system so that you can get the benefits so that you get the, it's a good thing for you, right? Where in reality, again, I think most people would opt not to be paying into the Social Security system and save for their own retirement if they were given the option, especially if their business was making money and given the fact that the Social Security system is clearly gonna have a problem at some point down the road because it's basically underwater as we speak. But, so it's just interesting to look at the framing of it. You already gotta see that it doesn't mean that information is wrong, but it's useful to look at the framing from the people that are giving you the information. So your payments of Social Security tax contribute to your coverage under the Social Security system. Social Security coverage provides you with retirement benefits, disability benefits, survivor benefits, and hospital assurance Medicare benefits. So as you're putting money, when we think about Social Security, there's two sides of it that we think about. One is the tax side when we're paying into the system and the other side is the benefits side when we're in retirement and we're gonna be paid out of the system. Note that Social Security and Medicare were actually put in place like during the Great Depression in the 30s and because there was this big problem that was happening and of course at that time and they were just entering laws like crazy. Most of which were probably detrimental extending the depression, but some of which, you know, stuck. But the idea of the Social Security and the Medicare at that time was more that it was a safety net program, meaning if people lost their savings for whatever reason that was like outside of their control or they lived past their life expectancy because they're living longer and they don't have the money to pay for their retirement, then we want a safety net to help those people, right? But then it grew to the point where now Social Security, we think of them as a country more like it's a retirement program that's government based, meaning everybody puts a substantial amount of money into Social Security and expects to get payments, not as a safety net program, not for those that need it, but for everyone. So that's a whole different kind of model that we're thinking about. It's kind of a weird change and it's kind of interesting if we're gonna go complete towards that change or not, is that good? Should it be a safety net or should it be more of like a universal retirement plan for federally funded, it's kind of weird, caution. So be sure to report all of your self-employment income by not reporting all of it, you could cause your Social Security benefits to be lower when you retire. That's gonna be the point. So as we're putting money in, we wanna try to maximize our Social Security benefits now, which is a difficult thing to do because it's a moving target and the laws could change at any given time going in, but the more money we put into the Social Security, the more we should get out in the terms of benefits. So how to become insured under Social Security. So you must be insured under Social Security system before you begin receiving Social Security benefits. You are insured if you have the required number of credits also called Quarters of Coverage Discussed Next. So earning credits in 2022 and 2023. For 2022, you receive one credit up to the maximum of four credits for each $1,510, $1,640 for 2023 of income subject to Social Security tax. Therefore, for 2022, if you had income, self-employment and wages of $6,040 that was subject to Social Security tax, you receive four credits. That's $6,040 divided by $1,510 for an explanation of the number of credits you must have to be insured and the benefits available to you and your family under the Social Security program, consult your nearest SSA office. So you can really dive into the research on that and dive into the weeds if you want. There's a lot of information. A lot of information. Caution, making false statements to get or to increase Social Security benefits may subject you to penalties. So that could be bad, that might be fraud if you're intentionally falsifying documents. The SSA time limit for posting self-employment income. Generally the SSA will give you credit only for self-employment income reported on tax return filed within three years, three months and 15 days after the tax year you earned the income. So there's like a statute of limitations on when to file that should be well within the timeframe that you would file, normal conditions. So if you file your tax return or report a change in your self-employment income after this time limit the SSA may change its records but only to remove or reduce the amount. The SSA will not change its records to increase your self-employment income. So who must pay self-employment tax? You must pay SE self-employment tax and file schedule SE self-employment schedule form 1040 if either of the following applies. One, your net earnings from self-employment excluding church employee income were $400 or more. So that's a substantially low limit. So most people that have a schedule SE are gonna have to file self-employment tax. So two, you have church employee income of $108.28. That's one of those ridiculously low numbers that never increased with inflation. So now it just looks funny. So we look at these numbers now and like, where did they come up with those numbers? Just laugh at it because they got stuck in the code and they never increased it with inflation. So now those numbers at one time were significant but now they look funny. Caution, the SE tax rules apply no matter how old you are and even if you are already receiving social security or Medicare benefits. So if you're subject to self-employment tax you have to pay the self-employment tax even if you're past the age of where you should be getting benefits from the self-employment tax. If you didn't have that, you can imagine people running scenarios where they're gonna have all these old people running the shell leader of the business just like that, what was that mob movie where they had the old guy pretending he was the boss but he wasn't the boss because they wanted to, because they wanted to get a tax benefit or something. Caution, SE tax rate. The SE tax rate on net earnings is 15.3%, 12.4% social security tax plus 2.9% Medicare tax. So notice that if we pull out the trustee calculator here if you're a W-2 employee, your withholdings are 0.062 or 6.2% and the employee pays the same plus 0.062 which is the 12.4, see? So you're paying the employee and the employer portion and then if you look at your Medicare that got withheld from your paycheck, then it would be 0.0145 or 1.45% times two and that's where you get the 2.9. So they're basically treating you as if you are an employee of your own business even though you didn't give yourself a W-2 but the net income is kind of treated like W-2 income because they're gonna be charging you basically payroll taxes on it but not just the employee portion of the payroll taxes they're gonna hit you with the employee and the employer portion in essence of the payroll tax. So maximum earnings subject to self-employment tax only the first 147,000 of your combined wages, tips and net earnings in 2022 is subject to any combination of the 12.4 social security part of the SAE tax, social security tax, self-employment tax, social security tax or the tier one part of railroad retirement. So you might ask why is that the case? If your schedule see income then is that 147,000 or more let's see your net income was 200,000 you're only gonna be paying that portion of the 12.4 not including the Medicare part the social security only part up to the 147,000 even though you made 200,000 why? You might say that's a benefit to rich people in that case they're benefiting rich people cause they stop having the pain of the social security tax well the idea would be well if when it was a social security when it was a safety net program then that would kind of then it wouldn't make so much sense you would say okay if it's a safety net program you wouldn't have that cap just as they don't have the cap with the Medicare it goes on forever because it's a low tax but now that we treat social security more as a retirement program that everybody's gonna benefit from then you would think that the more that you pay into the retirement program the more you should get in benefit a benefit concert and after you get to some threshold of income the benefits that are gonna be paid out are no longer being increased by added increases to your income and the amount of the tax rate 12.4% is significant and so that's why it kinda caps out there so people will always argue about that cap that's always a question if the government needs to be funded just raise that to infinity right but I mean obviously the issue here is that that 12.4% isn't a safety net level rate that's like a because it's being treated kind of like a like it's a retirement program for everybody and that's where it gets a little funny so people argue over that rate so but in any case that's where the cap is so it gets a little funny when you deal with higher income individuals to try to figure this out because if it's below that rate it's more of a flat tax and then it hits that cap which kinda makes things messed up a bit so all your combined wages, tips and net earnings in 2022 are subject to any combination of the 2.9 Medicare part of the SE tax that there is no cap here because Medicare is more of like a safety net program system Medicare tax and Medicare part of the railroad retirement so if wages and tips you receive as an employee are subject to either social security tax or the tier one part of railroad retirement tax or both and total at least 147,000 do not pay the 12.4% social security part of the SE tax on any part of your net earnings however, you must pay the 2.9 Medicare tax part of the SE tax on all your net earnings so in other words, you can imagine this gets even messier when you have self-employment tax that you're paying and you're working as a W2 employee which normally withholds half of the social security so now you've got a situation because you shouldn't be paying any more no matter where the self-employment income came from of this 147,000 and now there's actually a difference in terms of the amount of tax you would pay to get to that 147,000 because if you were a W2 employee you would only be paying half of this but when you're self-employed you've got to pay like twice of it and what if you were self-employed and a W2 employee and so then again so tip deduct one half of your SE tax as an adjustment to income on line 15 of schedule one so here's where it gets messy again because now like they're trying to make the self-employment tax as if you were the employee-employer portion of yourself for the net income on your schedule C and they're trying to mirror that to what happens on an employee-employer situation and like a C corporation but in a C corporation they deduct the total expenses of the earnings including the withholdings that they paid to the employee plus they get to deduct their half of the social security and Medicare tax as payroll taxes so if you're gonna tax us as a sole proprietor both the social security and Medicare employee employee or tax portion on the net income I should get to deduct at least the half of the tax that was like the equivalent of the self-employment half of the tax if I was a schedule C and so you can but you would then think well then I get to deduct that on the schedule C but you can't deduct it on the schedule C because then you'd end up with a loop reference a circle reference because you use the schedule C to figure out the tax in the first place so they gotta deduct it somewhere else so then you get to deduct half of the self-employment tax on the on the schedule one above the line deduction adjustments so additional Medicare tax there's a 0.9% additional Medicare tax applied to you if your net earnings from self-employment exceed one of the following thresholds based on your filing status so we saw that the social security portion gets capped and you don't pay anymore after a certain point but the Medicare not only doesn't get capped you actually increase the rate that you have to pay it's becoming progressive right so after some point you gotta pay more 0.9% so that's if married filing jointly over 250,000 married filing separately 125,000 single head of household or qualified surviving spouse 200,000 if you have both wages and self-employment income the threshold amount for applying the additional Medicare tax on self-employment income is reduced but not below zero by the amount of wages subject to additional Medicare tax you can use form 8959 additional Medicare tax to figure this tax so software is of course helpful which forms must I file so if you are liable for income tax then you got the form 1040, 1040 SR self-employment tax you gotta file the schedule SE estimated tax if you have to make estimated tax payments 1040 SE social security Medicare taxes and income tax withholding these are the payments of the withholding say if you were a schedule C business and then you were paying employees welcome employees if you're paying employees then you have to deal with the 941 to 944 the W2's not for yourself because you won't be paying yourself in that situation you'll be paying the employees you'll be dealing with social security and Medicare withholdings for those payments and you'll be dealing with the social security and Medicare for self-employment taxes on yourself for the net income of the business then you got the federal unemployment tax FUTA 940 filing information returns for payments to non-employees and transactions with other persons more information and then the excise taxes