How to Calculate Self Employment Tax
If you're a sole proprietor, business owner, freelancer, or contractor, you're likely familiar with the concept of self employment tax. Individuals who earn income working for themselves, rather than earning employer income, are still responsible for paying federal and state taxes. A portion of these taxes goes toward SECA taxes, which are comprised of Social Security and Medicare.
In this guide, learn how to calculate self-employment tax in a few straightforward steps to avoid surprises at tax time.
Here’s What We’ll Cover:
What is Self Employment Tax?
Self employment tax, known as SECA tax, ensures that self-employed individuals pay for their cost of Social Security and Medicare contributions. For employees who work a traditional W2 job, the employer pays a portion of these taxes, which are often referred to as FICA tax on a pay stub.
The acronym SECA is a reference to the Self-Employment Contributions Act of 1954, which established a precedent for self-employed individuals and business owners to pay 15.3% of all net earnings.
Who is Subject to Self Employment Tax?
Depending on your business structure and tax filing status, you may be liable to pay self employment tax. This is true if you meet one of the following criteria.
- You are a sole proprietor.
- You own a single-member LLC.
- You work as an independent contractor.
- You are part of a legal business partnership.
- You maintain active membership in a partnership LLC.
How is Self Employment Tax Different Than Income Tax?
Self employment tax is different from income tax, which includes both federal and state income tax. When you are self-employed, you are responsible for paying both SECA and income taxes on your own.
Income tax is something that is generated for everyone who earns money, regardless of how they are employed. Self employment taxes are only subject to individuals whose employers do not pay a share of their Social Security and Medicare taxes.
Steps to Calculate Self Employment Tax
Knowing how to calculate self employment tax is a beneficial skill that better prepares you when it's time to file taxes. Follow the steps below to get an idea of what you owe. When in doubt, always consult a tax professional or accountant.
Calculate Net Earnings
To begin, calculate your net earnings for the year. For self-employed individuals, this amount is usually found by subtracting total expenses from gross income or sales.
Net Earnings = Gross Business Income - Total Business Expenses
Understand the Self Employment Tax Rate
A simple search will reveal several calculators that you can use to discover your self-employment tax responsibility. Fortunately, the equation is rather simple. With the assumed self-employment (SECA) tax rate of 15.3%, you simply need to multiply your net earnings by this rate.
Apply the Tax Rate to Net Earnings
Multiply the tax rate by your net earnings.
SECA = Net Earnings * 15.3% (Tax Rate)
While it may not apply for income tax purposes, only 92.35% of your self employment earnings are subject to the 15.3% tax rate. If you choose to use an automatic calculator, or if you calculate your tax responsibility manually, keep this rule in mind.
Social Security Earnings Exception
In 2021, the first $142,800 in net earnings is subject to the Social Security portion of SECA taxes. This is an increase from the year prior. If your business generates more income than this, calculate accordingly.
Use Deductions to Your Advantage
There are many deductions available to self-employed individuals who need and want to reduce parts of their tax liability. One of the major deductions is the ability to deduct up to half of your self employment tax on your income taxes.
You should also carefully manage any business income deduction that may reduce your overall tax liability. This includes continuing education, home office equipment, expenses related to your website, and any investment that goes directly to support your self-employment income.
How to Pay Self Employment Tax
Once you calculate your self-employment tax liability, the next step is actually to pay. It's important that you make full and timely payments to the IRS to avoid interest or penalties.
Many business owners and freelancers choose to make quarterly tax payments, as it may reduce the amount of money you owe in back taxes and fees when you complete an annual return.
You can also use Schedule SE (Form 1040) to calculate additional options if your business experienced a loss or if you had very little self-employment earnings for a given year.
More Self Employment Resources
- Business Deductions for the Self-Employed: 12 Overlooked Tax Deduction Tips
- What Is SECA Tax? A Simple Guide to Self-Employed Tax Obligations
- How the Self-Employed Can Prepare for Tax Season All Year Long