Everything You Need to Know About Self Employment Tax

FT Contributor
A pen and cash sit on top of a document labeled "self-employment tax."

Self-employment tax is a tax imposed on people who are self-employed and is used to fund Medicare and Social Security. The self-employment tax rate is 15.3%. Self-employed people pay a higher tax rate into these programs because they function both as an employer and an employee for tax purposes.

When it comes to tax time, self-employment tax can sometimes be a confusing and unexpected expense for self-employed people. Understanding just how self-employment tax works can help you to put away money for taxes throughout the year, make the best use of any applicable deductions and tax credits, and know exactly what to expect when it’s time to file your tax return.

What Is Self-Employment Tax?

Self-employment tax is a tax imposed on people who are self-employed, including small business owners, sole proprietors, freelancers, and independent contractors. When an individual is an employee of another business, taxes are automatically taken out of their pay each pay period in order to fund social programs such as Medicare and Social Security. In addition, employers pay an equal amount of taxes into these programs.

Self-employed individuals are required to pay these taxes both as an employee and as an employer, resulting in a higher tax rate. Self-employment tax is paid on top of other forms of taxes, such as state and federal income tax.

Who Has to Pay Self-Employment Tax?

Any individual who earns over $400 in a single year from self-employment must pay self-employment tax. In addition, anyone who earns church employee income of $108.28 or more must also pay this tax. This can include small business owners, independent contractors, freelancers, and more.

Essentially, if you don’t have taxes automatically taken out of your income by an employer, you are subject to self-employment tax. Self-employment tax applies to all self-employed individuals, regardless of their age or income, including people who already collect Social Security benefits.

Self-Employment Tax Deductions

If you’re hustling as a freelancer or trying to stay in the black as a business owner, self-employment tax can be an unwelcome burden when it comes to filing taxes as a small business. The good news is that self-employment tax is itself a deductible expense.

Because self-employment tax is only charged on your net earnings, you can deduct the employer portion of the self-employment tax (7.65%) from your net income. In effect, this means that only 92.35% of your net income is subject to self-employment tax.

In addition, you can also subtract deductions such as business or office expenses to further lower your net income. If you’re not sure what deductions you might be eligible for, the IRS has a handy list of business expense deductions. You might also want to consider seeking professional help from an accountant or tax preparer to ensure you’re making the most of any tax breaks you may be eligible for, including deductions for dependents, student loan payments, retirement contributions, and more. Taking advantage of any applicable deductions can dramatically lower your self-employment tax burden come tax time.

Self-Employment Tax Rate

The self-employment tax rate is 15.3%. This consists of two main parts: a tax rate for Social Security of 12.4% and a tax for Medicare of 2.9%. This percentage is higher than the tax rate of regular W2 employees, since self-employed individuals pay taxes as both an employer and an employee.

In 2019, the first $132,900 in earnings is subject to Social Security tax, with the amount raised to $137,700 in 2020. The 2.9% Medicare self-employment tax applies to all net earnings. In addition, high earners may be subject to an additional tax rate of .09%.

How to Calculate Self-Employment Tax

Calculating self-employment tax depends on a variety of factors, including whether you already earn taxed income, what deductions you may be eligible for, and how much you make.

For example, if you earn $3,000 in self-employed income, and are able to deduct $1,000 in business expenses, you’re left with a net income of $2,000. Because you’re able to deduct the employer portion of self-employment tax, you’ll only pay taxes on 92.35% of your income, or $1,847. $1,847 multiplied by 15.3% results in a self-employment tax of $283.

How to Pay Self Employment Tax

Self-employed individuals can use the Schedule C of Form 1040 to pay self-employment tax to the IRS. In some simple tax situations, you can also use Schedule C-EZ. To pay your self-employment taxes accurately, you need to know your net earnings in order to calculate the correct amount of tax.

In many cases, self-employed individuals should make quarterly estimated self-employment tax payments using Form 1040-ES. These payments ensure that you pay taxes throughout the year rather than one lump sum at tax time.

While self-employment comes with many benefits, it can be a source of confusion and frustration when it comes to tax time. Although self-employment taxes may seem daunting when you’re first starting out, in reality, they’re very similar to the taxes you would pay as a typical W2 employee. By accurately calculating your net income and taking full advantage of applicable deductions, you can greatly reduce your tax burden and only pay as much self-employment tax as you have to.

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