Most people I know have the dream of one day working for their favorite employer: themselves.  While the benefits to being your own boss are numerous, there are also some downsides to the scenario.  One important factor to consider is the self employment tax.

First, what does “self employment” exactly mean?  According the IRS, an individual is self employed if he/she meets one of the following criteria:  (1) you carry on a trade or business as a sole proprietor or an independent contractor, (2) you are a member of a partnership that carries on a trade or business, or (3) you are otherwise in business for yourself.

For 2010, the self employment tax rate is 15.3%. 12.4% of this rate is for social security (old-age, survivors, and disability insurance) and the other 2.9% is for Medicare (hospital insurance).  The good news is that $106,800 is the maximum amount of earnings that is subject to the portion of the rate related to social security (12.4%).  Unfortunately though, your entire earnings amount is subject to the 2.9% Medicare tax.  Another plus of the social security tax is that you can deduct half of the tax paid to arrive at your adjusted gross income (AGI).

If you expect to owe tax (on both self employment income and regular income) of $1,000 or more at the end of the tax year, you have to make estimated tax payments if you do not have your income tax withheld.

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