Self-Employment Tax: Definition & Calculation
If you are working as an independent contractor, a small business owner, a self-employed worker, or a freelancer, you need to keep track of every little bit of income. This is because, for each bit of income, you may need to pay self-employment tax.
But what exactly is the self-employment tax? Do you need to pay it if you have a full-time job? And how do you pay for it?
Read on as we take a look at who has to pay the tax, how to calculate it, and what the tax deductions are.
Table of Contents
KEY TAKEAWAYS
- Self-employment tax is a tax that is collected from people who are self-employed as well as small business owners who don’t pay withholding taxes.
- This tax pays for Medicare and Social Security.
- It is reported on IRS Form 1040 Schedule SE.
- People that are considered to be self-employed include freelancers, independent contractors, and sole proprietors.
- You are exempt from paying self-employment tax if you earn less than $400 a year.
What Is a Self-Employment Tax?
The self-employment tax refers to the federal taxes that small business owners and self-employed people pay in order to support Medicare and Social Security. The self-employment tax is comparable to the Federal Insurance Contributions Act (FICA) taxes that an employer must pay. This tax is paid through their income tax return. This is for their income in income taxes.
What Is the Self-Employment Tax Rate?
The current self-employment tax rate is 15.3%. Broken down, this equates to 2.9% for Medicare payments, and 12.4% for Social Security.
Although it’s important to note that people who are employed and not self-employed split the bills on Social Security and Medicare. Whereas self-employed individuals have to pay both halves.
Who Does the Government Consider Self-Employed?
If you work for yourself in any capacity, the government likely considers you to be self-employed. When you are on a business payroll as an employee, the business takes taxes out of each check. When you get paid as an independent contractor, those taxes are not withheld from your payments. Instead, it is your responsibility to pay self-employment taxes. Other names for self-employed individuals include:
- Freelancers
- Contract employees
- Independent contractors
- Sole proprietors
- Small business owners
It is important to keep in mind that someone can have traditional employment and also be self-employed on the side.
How to Calculate Self-Employment Tax?
To calculate your self-employment tax, you first need to calculate your net earnings from self-employment for the year. This tends to be your gross income minus your business expenses.
Once you have this amount, you can calculate the 15.3% tax rate. Only the first $147,000 of earnings is subject to the Social Security portion of your self-employment tax. There is no income limit for Medicare taxes.
Who Must Pay Self-Employment Tax?
Self-employment tax must be paid if a person receives at least $108.28 from a tax-exempt church or a net self-employment income of $400 or more during the tax year. The tax is calculated and reported on Schedule SE of IRS Form 1040.
Self-employed people who earn less than these amounts are exempt from paying taxes.
How to Pay Self-Employment Tax?
You will most likely use IRS Schedule C to calculate your net earnings from self-employment. You’ll then use IRS Schedule SE to calculate the total amount of self-employment tax that you owe.
When you pay the tax, you’ll need to provide your Social Security number or individual taxpayer identification number (ITIN). In the United States, taxes are treated on a pay-as-you-go basis. This means that you shouldn’t wait until the annual tax-filing deadline to pay your taxes.
Many individuals will instead make quarterly estimated tax payments throughout the year.
What Are the Tax Deductions for Self-Employment?
On the tax on your income, you can write off half of your self-employment tax. So, for instance, if your Schedule SE indicates that you owe $4,000 in self-employment tax for the year, you must pay that amount as it is due throughout the year, but $2,000 will be deducted from your taxable income on your 1040 at tax time.
You can get a number of tax deductions from working for yourself. One is the qualifying business income deduction, which enables you to deduct up to 20% of your self-employment net income from your regular income tax.
Summary
Self-employment taxes are a tax on any self-employed individual that makes more than $400 a year from their endeavors. It’s important that any person who makes money from their self-employed work understands what this tax is and how to pay it.
If you are self-employed and miss your tax payments, then you can be subject to fines from the IRS.
FAQS on Self-Employment Tax
You can’t completely avoid paying any taxes. You can however lower your tax bill through things such as charity donations, subtracting allowed expenses, and making pension payments. You can also use income tax credits to reduce what you owe.
Self-employed individuals have to pay both self-employment taxes as well as their federal income taxes. This is the same for other individuals such as freelance income earners.
Self-employed people who make less than $400 annually (this is less when it is income from church employment at $108.28) are free from paying the self-employment tax.
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