Some fairly basic questions on taxes for a self-employed individual

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scintillator
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Some fairly basic questions on taxes for a self-employed individual

Post by scintillator »

I want to be able to ballpark what my tax burden will be if I decide to quit my job and become self-employed. I'm going to use round numbers to illustrate my questions.

I'm single and I work as an employee now and make $100k. I also own a house that I pay 5k in property tax on. And I receive 5k in dividends from VTI in a taxable account. So the IRS reckons this as $100k income minus the standard deduction, so $85,400, minus my half of FICA tax which I've paid from my earnings (7.65% x $85,400 = $6,533), so $78,867 is my taxable income, and so I owe about $12,658. And since I'm in the 15% bracket for qualified dividends, I'd owe 15% on the $5k, which is another $750. So I'd owe a total of $13,408 in federal income tax. (And I'll have paid the IRS $13,408 + $6,533 = $19,941. And including what my employer paid, the IRS received $26,474.) I assume I get no credit for the $5k I pay in property tax because it's less than the standard deduction. Does all that seem right?

Now say I leave my employer and make $100k as a self-employed traveling musician. All the above is the same except now I pay both halves of that FICA tax, so another $6,533. I remember reading this was deductible, but that plus my $5k property taxes would still be less than the standard deduction, so I guess it wouldn't matter for me. So $85,400 minus both halves of FICA is $72,334, so I'd owe $11,221. Add the $750 for the dividends, and it's $11,971 that I'd owe in federal income tax. (And I'll have paid the IRS $25,037 when you add FICA.) So the long and short of it seems like if I were self-employed, I would be paying an extra $5,096 to the IRS. (Although the IRS would receive $1,437 less than when I was employed.) Is all this basically correct? I sense I'm screwing up the FICA part, because while I say it's not deductible, I realize that I'm deducting it from my taxable income, which is pretty much the definition of deductible. But if I don't deduct it, that means I pay income tax on $85,400 even though I only received $78,876, which doesn't seem fair. I guess it could be even more unfair, and maybe I'm paying the 7.65% on $100k—that isn't the case, is it?
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FiveK
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by FiveK »

scintillator wrote: Sun Feb 11, 2024 2:18 pm I'm single and I work as an employee now and make $100k. I also own a house that I pay 5k in property tax on. And I receive 5k in dividends from VTI in a taxable account. So the IRS reckons this as $100k income minus the standard deduction, so $85,400
So far so good.
minus my half of FICA tax which I've paid from my earnings (7.65% x $85,400 = $6,533), so $78,867 is my taxable income
As a W-2 employee the 1/2 FICA tax is not subtracted for taxable income purposes
and so I owe about $12,658. And since I'm in the 15% bracket for qualified dividends, I'd owe 15% on the $5k, which is another $750. So I'd owe a total of $13,408 in federal income tax.
Your taxable income will be $90,400 and the Qualified Dividends and Capital Gain Tax Worksheet will compute your federal income tax to be $14,597. You will also have paid $7,650 in SS + Medicare tax, for a total of $22,247.
Now say I leave my employer and make $100k as a self-employed traveling musician.
Assuming that $100K is net after expenses (you do get to deduct mileage between gigs - but not between your home and a gig unless you can justify having a "home office" used only for your business - and other expenses), you get to subtract 1/2 SE tax for your AGI, and get a QBI deduction in addition to the standard deduction, so your taxable income will be $67,688 and your federal income tax will be $9,592. You will also owe $14,129 self-employment tax (i.e., both halves of FICA), for a total of $23,721.

Among other Tax estimation tools ("best" is in the eye of the beholder), you could use the personal finance toolbox Excel spreadsheet to put your 5000 qualified dividends in cell Calculations!D25, then put 100000 in either cell B3 or B30 to see what changes.
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Harry Livermore
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by Harry Livermore »

FiveK has your back here, especially pointing out that as a W2 employee you do not get to deduct 1/2 FICA. I seriously hope you have not been doing this on actual tax returns.
You also seem to think that you can deduct ALL of FICA when self employed (at least that's how I read it)
When an employee: your employer pays half of FICA, you pay half. No special deduction for this.
When self-employed: you pay BOTH halves of FICA. You deduct half.
I hope that makes sense.
There are many other aspects of being self-employed besides taxes, including the choice of entity (sole prop, corporation, etc.), segregation of accounts, tracking and documenting expenses, etc. Insurance should also be a top priority, both health and disability (you are single so less likely to want/ need life insurance) Have you thought through any of these other differences? In particular, you state that you earn $100K now. How certain are you that you can earn this while self-employed? Have you peeked behind the curtain at how performers are hired? Do you have a plan for promotion, networking, booking? Or do you already have some possibilities lined up? I've been self-employed for the entirety of my career and have enjoyed much success. It can be a terrific life, but very challenging at times.
Others can chime in. Feel free to continue asking questions, even if they go beyond the initial post's theme of taxes.
Cheers
humblecoder
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by humblecoder »

I am not an accountant or tax professional. So please don't rely upon me as a primary source. Fact check and do your own research.

I think you are missing out on the impact that any business expenses will have on your taxes.

When you own a business, your business expenses can be subtracted from your business income to determine your net profit. This is what you pay taxes on.

So if you make $100K from self-employment, you can offset this by any business expenses that you incur. For example, you say that you'd be a traveling musician. Therefore, presumably, you'd be buying plane tickets, staying at hotels, renting cars, etc. All of those expenses can be "deducted" from your business income. So if you make $100K, but you incur $20K of travel expenses to earn that $100K, you would only pay taxes on the $80K.

Self-employment tax (the 1/2 FICA that you'd be paying as a self-employed person) is also deducted as a business expense.

I think you might be getting confused by the word "deduction", as it has two meanings. First, you have the standard/itemized deductions which include property taxes, mortgage interest, charity, etc. You can either take a deduction based upon your actual spend OR the standard deduction, whichever is greater.

In the context of a business, a "deduction" is an expense that is incurred in the standard course of business. This is subtracted directly from your business income to get your net profit. So it is a separate thing from the standard deduction. It doesn't count towards it, but you also don't have to hit the standard deduction threshold to take it.

You might want to model out some of your scenarios in tax software so that you can get a feel for how it works. You might also want to take a look at Schedule C, which is the IRS tax form for reporting profit or loss from a business.
livesoft
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by livesoft »

You forgot the $23,000 deduction for your contribution to a 401(k). Could be more if you understand the rules and contribution more. Also if self-employed you will have to pay for some health insurance.

If a musician self-employed with work in many states, then you have to file tax returns for many states, too.

See also: https://www.irs.gov/businesses/small-bu ... f-employed
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Harry Livermore
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by Harry Livermore »

livesoft wrote: Mon Feb 12, 2024 8:03 am
If a musician self-employed with work in many states, then you have to file tax returns for many states, too.

See also: https://www.irs.gov/businesses/small-bu ... f-employed
Excellent point. Although I'm not a musician, I do often travel for work. Some years I have to do an additional state tax return or two. One year I had to do six!
Cheers
Topic Author
scintillator
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Re: Some fairly basic questions on taxes for a self-employed individual

Post by scintillator »

Thanks for all the great replies. My goal here is mostly for planning about possible options for myself and various people who ask my advice about financial matters. As you can see, I don't have much business opining on big financial decisions, but if I recommended that the people who ask me questions seek advice elsewhere, they'd just find someone even less informed or not bother doing any more work at all.

So to test my understanding here, say I'm self-employed, make $100k net of expenses, and make another $5k in qualified dividends. I contribute to both a solo-401(k) and a tIRA. And say I live in Oregon (which I assume recognizes 401(k) and IRA deductions, but has no special dividend treatments, and whose standard deduction is $2,605).

The feds reckon this as $100k - (standard deduction) - (solo-401(k) contribution) - (IRA contribution) - (half of FICA) = $48,750. Then I can shave 20% off that from QBI to get $39,000. And then my 5k in dividends gets taxed at 0%, so I'd just owe them income tax on $39,000, which is $4,460.

FICA just sees $100k of work income and demands I pay them $15,300. (That's brutal.)

Oregon reckons this as $100k - (Oregon standard deduction) - (solo-401(k) contribution) - (IRA contribution) - (half of FICA) = $60,745. Then I read Oregon has a reduced rate for business income of 7%, so I'd owe 7% on that $60,745, which is $4,252. And then my 5k in dividends gets taxed at the marginal rate of 8.75%, so $437. So I'd owe them $4,689.

The Oregon stuff is really guessing. I couldn't find info on whether half of FICA is deductible, and even the retirement-account deductions info isn't clear. It's ridiculous that most of the info I did find is not even on government sites, rather some third-party site or forums. And some places seem to say Oregon has its own 15.3% SSI tax, but I don't really believe that. But again, this is basically just so I can ballpark things. I would use software when actually creating the return.

The most important stuff is the federal estimate. Obviously I'd prefer to take the QBI 20% deduction from the $100k rather than post-deduction figure, but I assume the latter is how it's done, and that's also what's referred to as "below the line"?
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