Am I Self Employed?

Self-Employment Income In Retirement Can Catch You Off Guard

Self-Employment Taxes
Self employment taxes affect part-time work in retirement too. MichaelBlann/DigitalVision/GettyImages

Many retirees do part-time work, pick up odd jobs here and there, or start their own business.

When you do this, if you’re not careful, taxes can catch you off guard. This happens when you spend all that you make, forgetting that you'll need to pay both income taxes AND self-employment taxes on your earnings. 

To avoid a tax bill that you're not prepared for, you’ll need to figure out if you are self-employed.

If so, you'll have some new tax rules to learn.

Are you self-employed?

Sometimes you hear workers referred to as "1099 employees" or "W-2 employees". 1099 employees, often referred to as independent contractors, are considered self-employed and are responsible for their own payroll taxes. W-2 employees are not. Here's how you tell the difference.

You are self-employed if:

  • You do work for someone who pays you directly and does not withhold taxes. If they pay you over $600 in a calendar year they are supposed to report this income on a form 1099. This income is reported on your tax return on Schedule C. You can deduct your business expenses against this income to get your net income. You net income is your self-employment income and you will need to pay self-employment taxes (sometimes called payroll taxes) on this amount. 

You are NOT self-employed if:

  • your employer pays you, withholds taxes from your paycheck, and reports your income on a W-2 at year end.

    How self-employment taxes work

    When you work for someone and they pay you as an employee payroll taxes are handled for you. You can see on your pay stub that taxes are automatically calculated and withheld.

    When you are self-employed you are responsible for paying these taxes yourself. There are three types of taxes typically withheld from a paycheck:

    • Federal income tax
    • State income tax (if you live in state that has state income taxes)
    • FICA – Federal Insurance Contributions Act is the payroll tax, or employment tax, that United States workers pay to fund Social Security and Medicare. For a business owner this is referred to as the SECA (Self-Employment Contributions Act) tax.

    It is the last one, FICA or SECA taxes, that is called the self-employment tax and it will cost you 12.4% of your income for the Social Security portion and 2.9% for Medicare.

    That means for every $1,000 of net income (income left over after legitimate business expenses) you'll pay about $150 in FICA taxes. You'll also pay ordinary income taxes on that $1,000. You do get to deduct half of the amount of FICA tax you for the purpose of calculating ordinary income taxes.

    Why do self-employment taxes seem so high?

    As an employee you pay half of the FICA tax amount and your employer pays the other half.

    As a self-employed person you pay the entire FICA tax amount, both the employee and employer portion. In addition, you pay ordinary income tax. This means, even for a lower income person who is in the 15% tax bracket, as much as 30% of your money can be going to taxes.

    Newly self-employed people get themselves in trouble by not making high enough quarterly tax payments to cover both income and FICA taxes. If you are self-employed make sure with every bit of income you receive that you put a decent portion (at least 20-30%) into a savings account so you have enough set aside to cover your taxes.