Once your self-employment income as a writer, editor, illustrator or researcher shows a profit on Schedule C, that income will be subject to federal income tax and self-employment tax. It is not unusual for a self-employed person, finally breaking into profitability, to avoid federal income tax due to the standard deduction and personal and dependent exemptions, and other items on their tax return. However, the self-employment tax [SECA] is not part of that computation and usually survives as a “balance due” item.
When you are self-employed, you are required to pay your own self-employment tax on your business profit because you have no employer doing this for you. When you are an employee, working for someone else, they have historically withheld 7.65% of your gross wages from your paycheck for social security (FICA) and medicare, and they were required to match this amount with their own 7.65%.
Congress, to put more money into the ailing economy, lowered the employee percentage to 5.65% for 2011 and 2012 and lowered the self-employed rate from 15.3% to 13.3%. As of this writing, it seems likely this will not be extended and will go back up to the historical rates on January 1, 2013.
So, as a self-employed business man or woman, you are required to pay the combined self-employment rate of 13.3% in 2012 if you have a profit of $400 or more; if your profit is $399 or less, this is not an issue for you or if you show a loss.
As I said earlier, a significant amount of sole proprietors escape the federal income tax bite in that first and second year of profitability (since it is generally a lower amount and they have other offsets) but they get surprised by the independent self-employment tax calculation and assessment which is part of the personal Form 1040 tax preparation. For example, if your self-employment profit amounts to $2,000, your self-employment tax (by itself) would be $266 ($2,000 X 13.3%). Just to avoid any confusion, once your profit is more than $399, all your profit is subject to the self-employment assessment.
These payments are reported to the Social Security Administration and become part of your retirement contribution to determine your retirement benefits. The self-employment tax is computed on Form 1040 (SE) and is attached to your Form 1040 at the time of regular or e-filing along with your Schedule C and other required forms.
FICA stands for Federal Insurance Contributions Act and SECA stands for Self-Employed Contributions Act. However, these “contributions” are mandatory. Although you are not allowed to deduct this tax on Schedule C as a business expense, a portion of the self-employment tax is allowed on page 1 of your Form 1040 to lower your adjusted gross income and, thus, your taxable income.