 Hello, and welcome to this session. This is Professor Farhad. In this session, I will explain the self-employment tax. This topic is covered in an income tax course, surely the CPA exam regulation section as well as the enrolled agent exam. As always, I would like to remind my viewers to connect with me on LinkedIn if you haven't done so. YouTube is where you would need to subscribe. I have 1,600 plus Accounting, Auditing, Tax and Finance lectures. This course will go under my income tax course and will go under my CPA questions. Please connect with me on Instagram. On my website, you will find additional resources such as True, False, PowerPoint, Slides, Multiple Choice. If you're studying for your CPA exam, 2,000 plus CPA questions. If you are a CPA candidate, take a look. If you're an accounting student, take a look as well. So what is the big idea of self-employment tax? And where do students get confused with self-employment tax? Well, it's very important what I find helpful, actually, is explaining the idea from an employee perspective because when we talk about self employment, it means we are self-employed. Well, why do we have to pay this tax? What is that self-employment tax? Well, you do also pay some of it if you are an employee. What does that mean? Well, let's take a look at a paycheck and I'll explain to you because it's very important to understand as an employee, as an employee. What is your share? Because that's important to understand the self-employment tax. So if you don't understand the employee picture, it's going to be confusing to understand the self-employment. So as an employee, you get paid and for the sake of illustration, this is your first pay stop. You were paid for this paycheck and this is Julie Jones as a sample. It doesn't matter who are we paying. We paid this individual gross amount of $1,083. So this is what the company paid this individual. Now this individual will have money taken from their paycheck. So notice they have federal income tax withholding $1,222. They have state. They have federal OASDI or Social Security. Here we go. Let's focus on this. So as an employee, the company will take from your paycheck certain amount of money. Now that certain amount of money is not, is not random. That certain amount of money is your gross amount times, times, times 6.2 percent times 6.2 percent. So this is your Social Security or OASDI. Old age survivor and disability insurance EE the employee. Notice here they said EE, which is that's why I picked this example. So if you take 1,083 times 6.2 percent, you pay $67, $67.15 in SS Social Security tax as an employee. Well, let's keep going. Let's look at the next slide. On the next slide, you have federal Medicare EE or Medicare. $15.7. Also, it's no coincidence how we arrived to that number. It's 1,083. Now we're going to look at the Medicare. 1,083 times 1.45 percent. If you do this computation, you're going to get $15.70. So that's the Medicare tax. Now, this is what the employee paid. Now, what you don't see, what you don't see is the employer portion. So as an employee, you don't know, or you might know, but it doesn't matter, but you have to know that your employer, the company that you work for, also paid $67.15 and also paid $15.70. Simply put, they matched your contribution. You contributed this much to your Social Security. They matched it. You contributed this much, which is $15.70 to your Medicare. They matched it. So simply put, the Social Security rate between the employee and the employer, it's 6.2 plus 6.2 equal to 12.4 percent. So that's the Social Security rate. Now, what else do we need to know about the Social Security rate? Something we need to know that you are subject to a Social Security tax up to a point. Now, for this year, we're in 2020, I believe the amount is $132,900. It doesn't matter what the amount is, but the amount is always given to you as, so simply put, once you earn more than that, they stop paying from your, they stop taking money from your paycheck in terms of Social Security. For Medicare, it's 1.45 for the employee plus 1.45. Simply put, it's 2.9 percent. That's the Medicare rate, but they split it. The employee pays something, the employer pays something, and here there's no limit. So they don't stop taking Medicare at any point. So why am I explaining all of this? Because now let's go back to what we need to talk about. If you are employer, if you are self-employed, guess what? If you are self-employed, you are the employee, and you are the employer. You are both. If you are self-employed, you have to pay both. You have to pay 12.4, 2.9, which is, let's do it Social Security, 6.2, 6.2, 1.45, 1.45. Okay, now there you go. Now you understand that as a self-employed individual, you have to pay both taxes. Now the company, the company, I erased what's on the other slide. I forgot to tell you, because before I erased them, the employer share, the employer share is deductible. So remember the employer matched some of it. That employer share, they deduct it on their taxes, so they get a tax deduction. Now as a self-employed, you don't, you cannot deduct your share. You cannot deduct half. Therefore, what's going to happen? Because you cannot deduct half, which is what's half, 7.65%. So copy this number down. So the company can deduct 7.65, their share. Because you're the employee and the employer, you don't deduct 7.5. So what's going to happen with the 7.65 government that's going to give you a break? So this is the idea. Now let's take a look at the steps when you compute your self-employment tax, and you're going to see why I went through it. So let's take a look at the steps to compute the self-employment tax. Step one, we're going to, we're going to do it step by step just for explanation, but you could use your own method. Compute the amount of taxpayer net income from self-employment activity. Usually this is your, you know, from schedule C, it's your income from self-employment, which is your revenues minus your expenses. It's as simple as that. Step two, you multiply that amount in step one by 92.35%. What we get is net earning from self-employment. Now the question is why 92.35%. Why, why this number? Well, there is no, it's not coincident that this number is 100% of your earning minus 0.765, which would give us 92.35%. And what is 0.765? Well, it's 6.2 and 1.45, 7.65%. What is this? This is the government to give you a break because you're paying both. They're going to give you a break. So they're going to lower your self-employment and income and make it net earning from self-employment. So when you take your income multiplied by this rate, you're going to get your net earning from self-employment. Why do you do so? Because they want to give you a break because as a company, the company gets a break for half of their social security break. In a sense, they get deduction. You also have your, you're entitled to that because self-employed taxpayer are responsible for paying the entire amount of their fight a share. They are allowed an implicit deduction for 7.5, 7.5 of the employer portion of the taxes, leaving 92.35% of the full amount subject to self-employment tax. Note, 7.65 is 6.2 plus 1.45. Now, bear in mind, net earning from self-employment is the base for self-employment tax. So if your net earning from self-employment is less than 400, you don't have to worry about the self-employment tax, but you're still subject to income tax but not self-employment, just FYI. So now, step one, simply put, all step one, I explained it to you, but this is in writing. Step three, well, step three, compute the social security tax, which is the 12.4 portion. The social security tax of the self-employment equal to 12.4 multiplied by the lesser of, here we go. Remember, social security, there's a limit. There's a limit. And the limit for the purpose of this example, the year that we are in is 132.900. So what you do with the step three for social security is you take the lesser of, so you would choose the lesser of, the lesser of, step two, or the limit, whatever that limit happens to be. The limit happens to be, for our example, 132.900 for year 2020. So the limit between step two or 132.900. Now, why the lesser of these two? Because if you earn less than 132.900, you only pay taxes on that amount. If you earn more than 132.500, you only pay taxes on 132.900. So that's why you're limited to 132.900. Now, step four, which is Medicare, it's easy. What's step four? You'll take the amount and you multiply it by 2.9. The amount from step two, you multiply it by 2.9. There's no limit, nothing to choose because there's no limit to worry about. The best way to illustrate this is to look at an example. Compute the self-employment tax on 150,000 of self-employment income. Well, step one is giving. Step one is 150,150,000. I'm giving self-employment income. Step two, take the 150,000 multiplied by 0.235. So as a self-employed, you get a credit, you get a deduction, you get a break because you're both the employer and the employer. So let's take a look at 150 times 0.9235. And that's going to give us 138,525. And this is your step two. So this is step two figure. Now, what we need to do, we need to compute our social security component and our Medicare component. Well, social security component is we're going to take the lesser of step two or the limit. The limit is 132,900. So we're going to take the limit because the limit is lower, 132,900. You're not going to pay taxes 138,525. Social security of the limit is 132,900. They only have to pay social security up to a point times 12.4. And that's going to give you 16,479.6. We're going to look at Medicare. Medicare, Medicare tax, guess what? It's the 138,525, whatever you computed in step two times 2.9. And that's going to give you $4,017.22. When we combine those two together, that's $20,496. Now, if you want to go a step further, you might be asked, give me the employee portion and the employer portion. Well, divide by two. And whatever the answer is, half of it the employee, half of it is the employer, which is $10,248 for the employee portion. And $10,248 is the employer portion. And that's basically self-employment tax in a nutshell. If you find this recording helpful, I strongly suggest you visit my website for additional resources if you're studying for your CPA exam. You don't want to take any chances. Study hard. Invest in your career. You invest once in your lifetime for 20, 30, 40 years in your career. 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