Self-employment tax is made up of Social Security and Medicare taxes. Read more to find out how to calculate it and what your obligations are.
What is self-employment tax?
Self-employment tax is paid by small business owners to the US federal government, in order to fund Medicare and Social Security. Meaning, if you are a self-employed individual, you will need to pay self-employment tax as a condition for receiving Social Security benefits when you retire.
The self-employment tax rate is 15.3%. That rate is the sum of a 12.4% for Social Security and 2.9% for Medicare. Self-employment tax applies to net earnings — what many call profit. This tax needs to be paid throughout the year, by method of quarterly estimates.
Why do self-employed individuals need to fund social welfare programs?
In a normal business, both the company and the employee are taxed to fund Medicare and Social Security. The IRS sees self-employed individuals are being both the company and the employee. This means that if you are self-employed, you need to pay both portions of this tax, as you do not have an employer deducting the tax.
What is the threshold for paying self-employment tax?
You have an obligation to pay self-employment tax once your net earnings are $400 or more for the tax year from self-employed income. For a tax-exempt church, this is $108.28 or more. If you are self-employed and make less than these thresholds, you don’t need to pay any tax.
Social Security tax only applies to the first $142,800 of self-employment income earned, for a maximum tax of $17,707.20 in the 2021 tax year. For the 2022 tax year, it’s applied to the first $147,000 of income, for a maximum tax of $18,228. Social Security tax is assessed at a rate of 6.2% for an employer and 6.2% for the employee. Therefore, a self-employed worker will be taxed 6.2% + 6.2% = 12.4%, as they are considered to be both an employer and an employee.
Medicare tax has no income limit. Medicare tax is assessed at a rate of 1.45% for an employer and 1.45% for the employee. A self-employed worker will therefore be taxed 1.45% + 1.45% = 2.9%, as they are considered to be both an employer and an employee. The total self-employment tax rate is, therefore, 12.4% + 2.9% = 15.3%
In order to determine whether you are subject to paying self-employment tax, you first need to figure out your net profit or net loss from your business. Do this by subtracting your business expenses from your business income. If your expenses are less than your income, the difference is net profit. Net profit becomes part of your income on page 1 of Form 1040 or 1040-SR. If your expenses are more than your income, the difference is a net loss. Usually, you are able to deduct your net loss from gross income on page 1 of Form 1040 or 1040-SR. In some situations, your loss is limited.
Do high-income earners face an additional self-employment tax?
Yes, high income earners face an additional self-employment tax as a result of the Affordable Care Act (ACA). Earnings over $200,000, or $250,000 for married couples filing a joint return, are subjected to an additional 0.9% Medicare tax.
Example of self-employment tax
Self-employed individuals typically pay self-employment tax on 92.35% of their net earnings, not 100%. An individual running a business, who calculates their total net income for 2020 to be $200,000 after business expenses have been deducted, will be taxed on 92.35% of $200,000 = $184,700. As this amount is above the maximum threshold for the Social Security portion of the self-employment tax, this individual’s tax will be (12.4% of $137,700 = $17,074.80) + (2.9% of $184,700 = $5,356.30) = $22,431.10.
Tax deductions for self-employment
Half of this self-employment tax can be deducted on your income taxes. For example, if your Schedule SE says you owe $2,000 in self-employment tax for the year, you’ll need to pay that money when it’s due during the year, but at tax time $1,000 would be deductible on your 1040.
Home office deductions
As a self-employed individual, you may use your home as an office space. If you do used part of your home for your business, you may be eligible to deduct expenses for the business use of your home. This ‘home office deduction; is available to both homeowners and renters.
Other Self-Employed Tax Deductions:
There may also be other deductions that you are eligible for, including the Health Insurance deduction. You can deduct medical and dental insurance premiums for you, your spouse, your dependents and your children who are younger than 27 at the end of the tax year.
Other deductions include:
- Continuing education: you can deduct work-related education expenses, such as tuition, books, supplies, transportation and more.
- Business car costs: you can deduct just over $1 for every two miles driven for business purposes.
- Business travel and meals: you can deduct flights, hotels, taxis and food if spent for a legitimate business purpose.
- Business insurance premiums
- Office supplies: you can deduct costs including stationary, postage and other similar items.
- Credit card and loan interest: you can deduct interest accrued on purchases that were business expenses.
- Phone and internet costs: you can deduct your entire phone and internet bills if you have a dedicated business phone or internet connection.
- Advertising costs
- Retirement savings
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What is the qualified business income deduction?
The qualified business income deduction, or QBI, is at or below $163,300 doe single filers, or $326,600 for joint filers. This deduction is for individuals with ‘pass-through income’. This is business income that you report on your personal tax return. Entities eligible for the qualified business income deduction include sole proprietorship s, partnerships, S corporations and limited liability companies (LLCs).
This deduction phases out for some business, so you might still be able to claim it if your income is above this limit.
Who is considered self-employed?
Self-employed individuals include sole proprietors, freelancers, and independent contractors who carry on a trade or business. Members of partnerships that carries on a trade or business may also be considered as self-employed by the IRS.
What is a freelancer?
A freelancer is someone who earns money on a per-job or per-task basis. This kind of work is typically short-term.
What are the self-employment tax obligations?
Self-employment tax is reported on Form 1040 Schedule SE. your obligations are generally to file an annual return and pay estimated tax quarterly.
The Coronavirus Aid, Relief, and Economic Security (CARES) Act, defers payment of the employer portion of self-employment taxes attributable to Social Security for the period of March 27, 2020, through Dec. 31, 2020. It defers payment of 50% of those taxes until Dec. 31, 2021, and the other 50% until Dec. 31, 2022. This was signed in by Trump in March 2020.
How do I make quarterly payments?
Social Security and Medicare taxes and income tax are paid through an estimate by self-employed individuals, as you do not have an employer withholding these taxes for you. You can figure this out using Form 1040-ES, Estimated Tax for Individuals. This form contains a worksheet similar to Form 1040 or 1040-SR. In order to fill out Form 1040-ES, you will need your previous year’s annual tax return.
If this is your first year being self-employed, you will need to estimate the amount of income you expect to earn for the year. If you estimated your earnings too high, simply complete another Form 1040-ES worksheet to refigure your estimated tax for the next quarter. If you estimated your earnings too low, again complete another Form 1040-ES worksheet to recalculate your estimated taxes for the next quarter.
You’ll need to provide your Social Security number or individual taxpayer identification number (ITIN) when you pay the tax.
These taxes are a pay-as-you-go in the US, so waiting until the annual tax-filing deadline to pay your self-employment tax may mean incurring late-payment penalties. Instead, you may need to make quarterly estimated tax payments throughout the year if you expect:
- to owe at least $1,000 in federal income taxes this year;
- that your withholding and refundable credits will cover less than 90% of your tax liability for this year or 100% of your liability last year, whichever is smaller.
If I am self-employed will I need to file an information return?
In most cases, yes, you will be require to file an information return to the IRS if you have made or received a payment as a self-employed individual or small business.
What is a Qualified Joint Venture?
Married couples filing a joint return, can elect not to be treated as a partnership for Federal tax purposes under a ‘qualified joint venture’. This is because of the Small Business and Work Opportunity Act of 2007.