Taxes for the self-employed can be confusing and frustrating. It’s also one of the biggest areas of fear for my coaching clients.
I’m not an accountant or tax preparer, but I’ve been a nerd about understanding my own taxes for long enough to address some common music teacher tax myths!
Myth #1 “If I was an employee, I wouldn’t have to pay taxes at all.”
It’s a nice thought, but it’s not true.
If you have ever been an employee and gotten a refund at the end of the year you might not have felt like you were paying taxes, but you were. Your employer just withheld a portion of your paycheck every pay period and sent it off to the government on your behalf.
If your employer withheld and submitted more than you really owed you get a refund of the suplus when you file your tax return.
When you’re self-employed, there is no employer above you withholding taxes. Instead, you’re responsible for making your own quarterly estimated tax payments. Trust me when I say you feel every penny when you pay taxes this way!
Myth #2 “If I was an employee I would pay LESS in taxes.”
Maybe, maybe not. There are some variables here.
If you’re strictly looking at tax rate percentages, it’s true that employees pay a smaller percentage:
- Self-employed individuals pay self-employment taxes of 15.3%*
- Employees pay employment taxes of 7.65%*
But the math is a little more nuanced than just a percentage.
Employees and self-employed individuals are actually taxed on different income.
Let’s say you’re self-employed and earn $50,000.
You spend $10,000 on expenses related to running your business (cell phone, internet in your studio, mileage, software and apps, conference and travel fees, etc.).
That $10k is deducted from your income before any taxes are calculated. You would pay self-employment taxes on that remaining $40k.
If you’re an employee, you might have some of the same expenses (conference fees, cell phone, maintaining instruments at home), but they are generally paid out of pocket after taxes.
So if you earned $50k as an employee, you would pay employment taxes on that $50k and then have to pay your expenses.
Now, 7.65% of $50k ($3,825) is still less than 15.3% of $40k ($6,120), but when you’re self-employed you set your own rates!
Knowing you’ll have these extra tax responsibilities is just one of the reasons you should charge more per hour as a self-employed teacher than you would earn as an employee.
The Bottom Line
The amount you pay in taxes is one measure, but it’s what you’re left with after you pay them that really matters.
That last example had us earning the same amount whether we were employees or self-employed, but that’s probably not the case in real life.
This example probably paints a more realistic picture of the employee/self-employed tax comparison:
Let’s say a student pays $50/hr for lessons.
If you’re an employee, your employer collects that $50 and pays you $30. (Remember, they’ve got to pay taxes, invest in marketing, and cover other business expenses with that other $20.)
After your employment taxes of 7.65% are withheld ($2.30), you take home $27.70.*
Now let’s say you’re self-employed:
You collect the full $50/hr for your services and spend 20% of that income ($10) on business expenses. Since you’re self-employed you can write off those expenses, which takes the income subject to self-employment taxes down to $40.
Self-employment taxes on $40 is 15.3% or $6.12, so your take home hourly rate is about $33.88.*
So, yes, a $2.30 tax bill is less than $6.12, but your bottom line earnings on lessons that cost the same amount to students is higher.
Note: I don’t say this as a judgement on whether being an employee or self-employed is “better.” (That totally depends on your goals, values, and giftings!)
I’m just illustrating how there’s a bit more to this myth than meets the eye. The tax rates are not the only relevant factor.
(*On top of employment or self-employment taxes, you’ll also pay federal income taxes and possibly state and local taxes, but those tax rates are the same for employed and self-employed individuals.)
Myth #3 “Making estimated quarterly tax payments is optional.”
Well, I guess you could say that it’s “optional” in the same way that obeying traffic laws is “optional.” You can ignore the rules, but there might be consequences.
The following are quotes from the IRS website (emphasis added):
“If you are in business for yourself, you generally need to make estimated tax payments.”
“Individuals, including sole proprietors, […] generally have to make estimated tax payments if they expect to owe tax of $1,000 or more when their return is filed.”
“You may have to pay estimated tax for the current year if your tax was more than zero in the prior year.”
And the consequences…
“If you don’t pay enough tax through withholding and estimated tax payments, you may be charged a penalty. You also may be charged a penalty if your estimated tax payments are late, even if you are due a refund when you file your tax return.”
So, not exactly optional. You can read more about that here: https://www.irs.gov/businesses/small-businesses-self-employed/estimated-taxes
Myth #4 “I paid more in taxes than I earned.”
I’ve only heard this myth once, but it makes an important point so I’m including it.
Unless you were gifted a ton of money and have to pay exorbitant gift taxes (an unlikely scenario), you won’t pay more in taxes than you earned. The math just doesn’t work that way.
Income taxes and self-employment taxes are calculated as a percentage of your earnings and that percentage is less than 100%. Much less.
Now, it is possible that the amount you spent on taxes plus living and/or business expenses exceeded your income. That is certainly a problem, but it has to do with budgeting, not tax rates.
Hopefully this post will start to clarify some things for you as we enter tax season.
As I mentioned at the beginning of this post, I am not a trained tax preparer or accountant. These are generic examples and should not be considered advice for your situation. To get specific answers to your tax questions you should consult a tax professional.