Employees are the backbone of any organization. This is why companies spend a considerable amount of time in hiring, training, and retaining efficient employees. Payroll plays a significant role in the retention of employees. To continue their employment in the organization, employees need assurance that they will always be compensated on time.
Paying the due salaries in time reflects the company’s financial stability, which is critical in retaining the trust of the stakeholders in the organization. It also helps boost the employees’ morale while maintaining the company’s reputation.
Self-employment means instead of working for another person, you’ll be working for your venture. Sole proprietors, individual contractors, freelancers, or partnerships are the popular forms of self-employment. However, employees working in an organization must be compensated for their work and time. This compensation is known as payroll.
Payroll can be defined as compensation provided by the organization or an employer to its employees for the work performed by employees. Whether small, medium, or large, an organization must manage its payroll effectively and efficiently.
Since payroll involves paying the employee wages for the work and time given committed to a company’s operations, sole proprietors (self-employed) cannot pay themselves wages or withhold taxes.
What Is Self-employed Payroll?
Self-employed payroll is a taxable income paid to the self-employed individual or a sole proprietor from the business’s fund. You are self-employed when you work for your company instead of working for another person or entity for a pre-defined consistent wage.
An individual owning an unincorporated business is a sole proprietor, or an independent contractor is essentially a self-employed individual. The business structure of a self-employed individual can be a Sole Proprietorship, a Limited Liability Company (LLC), or a Partnership.
How to Set up Self-employed Payroll?
Setting up payroll for self-employed can be completed using the following steps by a self-employed individual:
- Apply for Employer Identification Number (EIN). It is a unique nine-digit number offered to businesses for easy identification in tax purposes. Without this number, an organization cannot pay the taxes withheld from employees or obtain tax identification for business expansion.
- Collect the tax information of employees. It assists self-employed business owners in withholding an appropriate amount for taxes.
- Set a payment schedule for timely disbursement of wages.
- Calculate the gross wages to determine the amount to be deducted from an employee’s paycheck.
- Deduct the taxes and other withholding amounts like federal and state taxes, FICA taxes, etc., from the employees’ paychecks.
- Determine the payment distribution channels. For example, you can either pay employees through direct deposits or other payment methods like cash, checks, payroll cards, etc.
- As an employer, you must submit the tax deposits to the IRS and prepare the correct forms within the due date to avoid legal hassles and penalties.
Payroll Options for Self-employed Individuals
Various options can be used for self-employed payroll purposes. However, the process must be legal and ethical to avoid tax discrepancies.
After setting up the self-employed payroll system, its authenticity should be checked to ensure compliance with the local and international laws wherever applicable. Self-employed payroll transfers can be made in the form of the following ways:
- Withdrawing money from the business by the self-employed individual. Such withdrawals are not considered a regular expense and are not subject to income taxes in many countries, including the US.
- The most common payroll option for self-employed individuals is receiving regular salaries like the other employees. This is done by classifying the owners as the employees of the organization. Such wages are subjected to taxation.
- In partnerships, the business owners are provided payroll in two forms: guaranteed payments and distributions. Guaranteed payments are the payments ensured to the owners for a specific period irrespective of the income generated by the business. On the other hand, a distribution is a set percentage allocated to each business partner, based on which the profits and losses are divided amongst them.
- A self-employed individual may also receive payroll in the form of dividends. Dividends are regular payments to the shareholders of the business from the earned profits.
In an international business setting, self-employed payroll transfers can be made using payroll service providers. These service providers help businesses by completely taking charge of their payroll process. Such payroll services calculate the pay accrued to the employees and file the due taxes.
- Traditional Payroll providers: These are well-established payroll providers that handle the entire payroll process for small businesses with few employees or large corporations with thousands of employees.
- Payroll providers: Many employment service providers take care of payroll services. For example, Multiplier incorporated in 2020 is a payroll service provider that ensures tax compliance and is a global payroll processing firm.
Using the services of the accountants for the payroll service providers for self-employed payroll transfers is also common. The accountants would process the payroll for the self-employed individual and ensure there is no discrepancy in the tax compliance regulations by paying the taxes in time.
Steps of processing payroll with payroll service providers:
- Select a full-service payroll provider, such as Multiplier, a digital platform for global payroll processing while ensuring full adherence to the local and international tax laws.
- Adding the owners as self-employed individuals and other employees in the system
- Tracking the work hours to ensure accurate payouts
- Processing the payroll on the pre-determined date
- Tracking the payments made and tax filing to avoid errors and penalties
Self-employed Payroll Taxes
Self-employed individuals who are working for themselves pay self-employed payroll taxes. These taxes are for social security globally and in some countries also for medicare purposes. These taxes are similar to what regular employees pay from their income for social security and medicare.
Interestingly, the amount of tax is almost the same for both the employer and the employees or the individuals on self-employed payroll; however, the calculations for the taxes are different for everyone. The taxes are based on:
- An individual’s wages or salary earned during the year.
- The individual’s profit earned during the year. If the business does not make profits, the self-employed individual does not pay taxes. But, if the company earns profits, self-employed people must pay taxes at 15.3% in the United States.
The employer and the employees share the self-employed tax rate. The entire amount is debited as taxes from the self-employed payroll. However, they can get half of it back in the form of a tax return. This deduction affects the income tax without impacting the income.
The individuals need to pay self-employment taxes if they:
- The individual earned more than $400.
- The self-employed individual is working as a sole proprietor or individual contractor.
Requirements of paying tax for the self-employed individuals:
- Social security number
- Individual Taxpayer Identification Number.
As a self-employed individual, paying the taxes every quarter in advance is mandatory. Consequently, you will be required to file an annual tax return to receive back the taxes paid more than the actual tax.
Process overview of tax for the self-employed individuals:
- Calculating the business’s net income – It is vital to calculate the business’ net income because the net profit or net loss would be used to find out what the tax for the self-employed individuals would be. This could be obtained by subtracting the business expenses from the business income. If the income is higher, we have a profit, and if not, there’s a loss.
- Calculating the amount that the self-employed individual owes – Globally, about 92.35% of the total profit is subject to tax for the self-employed individuals. The amount received is then multiplied by the predefined tax rate. However, the amount received must be divided into half because of tax deductions, and the rest should be paid as the tax return.
- Payment of Self-employed taxes – Taxpayers must pay taxes on their income as they receive it. Since the individuals on self-employed payroll do not get salaries, they must pay their taxes in advance.
Employment compensation is provided to the employees, and the employers must pay the payroll taxes. Governments throughout the world receive payments from self-employed individuals as their income taxes and self-employment taxes.
Incomes taxes are percentages deducted from the net earnings paid to the government. These taxes are divided into slabs basis on which percentages are decided. On the other hand, self-employment taxes have set percentage rates. Apart from the income taxes, some states and territories in different countries require individuals to pay state payroll taxes and local taxes.
Self-employed individuals have the advantage of deducting the total tax in half. However, individuals on self-employed payroll have to pay both the employer’s share and the employee’s share, and thus the taxes of the self-employed individuals must be divided in half.
Self-employed Payroll Forms
Like the other taxes, you must fill out a few forms while filling out self-employment payroll tax. Some of the forms are mentioned below:
- Form W-2: It includes information on the income earned during the year and withheld taxes.
- Form 941: This form helps understand the amount of taxes that an individual on self-employed payroll or otherwise owes the government. Here, individuals must provide details such as the identification number and if tax applies to them.
- Form 940: This form is required to calculate the Federal Unemployment Tax towards the compensation of unemployed people or those who have lost their jobs. This form is only filled by the business owners and is not deducted from the employee’s payroll.
- Form 1099: This form is essential to note all the incomes that have been received from people other than the employer.
- State and Local tax forms: Some provinces in different states require individuals to pay various state and local tax forms.
Generally, employers pay their employees salaries or wages, but self-employed individuals must pay themselves by deducting the taxable amounts from their business funds. This is termed self-employed payroll.
When individuals transition from being an employee to self-employed business owners, they must pay the taxes for the self-employed individuals. It is calculated on the net income earned during the year. An individual on self-employed payroll must pay estimated taxes quarterly in advance, which can be retrieved via the income tax return.
These self-employed taxes are paid for receiving benefits from the government, and the taxes are generally paid towards the security and medicare funds. Apart from this, self-employed people must prepare several forms by year-end and comply with numerous rules, which makes the payroll process more tedious to maintain.
Thus, selecting an employment solution provider such as Multiplier can be useful. By outsourcing payroll services through Multiplier, you can save time and money. By trusting your payroll management operations with us, you can focus on administration activities and business development.
Frequently Asked Questions
Q. Is it necessary for a self-employed individual to hire an accountant?
In a situation where the self-employed individual is inexperienced in filing the personal and business taxes, it is suggested that they seek professional advice or help.
Q. If an individual did not make any money in their self-employment business, do they still have to pay income tax returns?
If the self-employed individuals did not have any other source of income than their self-employment business and their earnings were less than $400, they need to pay the income tax returns.
Q. Does an individual pay self-employment tax even on the passive income?
No, individuals need not pay taxes on the passive income, but they must pay the income tax.