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What Is Self-Employment Tax
Self-employment tax is a term used to refer to Social Security and Medicare taxes that individuals who work for themselves are required to pay.
In other words, self-employment tax represents the Social Security taxes and Medicare taxes that self-employed individuals pay.
When someone is employed in a company, the employer deducts the Social Security and Medicare tax directly from the employee’s wages.
However, self-employed individuals are required to pay the self-employment taxes themselves by using Schedule SE on their personal income tax return.
The self-employment tax is 15.3% where 12.4% goes to Social Security and 2.9% goes to Medicare.
One important difference between the self-employment tax and the payroll tax is that self-employed individuals are required to pay the entire self-employment tax whereas payroll taxes are split up between employees and their employer.
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Who Must Pay Self-Employment Tax
Self-employment taxes can apply to many different types of people like freelancers, independent contractors, small business owners, or anyone earning an income on their own.
According to the Internal Revenue Service (IRS), self-employment tax applies to individuals who have net earnings from self-employment activities in excess of $400 in a given year or church employees having an income of $108.28 or more.
Everyone in the United States is required to comply with these tax rules.
As a result, if you are generating an income through freelance activities, side hustle, or business, you must ensure you pay your self-employment taxes.
Note that family caregivers who provide in-home services to elderly or disabled individuals have special rules to comply with.
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How To Calculate Self-Employment Tax
To calculate your self-employment tax, you must first calculate your net income.
To determine how much is your net income, you must take your gross income (which is your total self-employment revenues) less your business expenses (which are expenses incurred to generate revenues).
Then, you take 92.53% of your net earnings to determine how much of your net earnings is subject to self-employment tax.
From your eligible net earnings, you will then take 15.3% to calculate your total tax.
According to the IRS, you should keep in mind that $147,000 of your earnings is subject to Social Security tax (this amount was $142,800 in 2021).
The total tax that you’ve calculated by taking 15.3% of your eligible net earnings represents what you must pay to Social Security and Medicare.
In fact, 12.4% of it goes to Social Security and 2.9% of it goes to Medicare.
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How To Pay Self-Employment Tax
The payment of self-employment tax is a “pay-as-you-go” type of tax.
In other words, you’ll need to calculate your self-employment tax during the year and send your payment at regular intervals.
This means that paying your self-employment tax is not necessarily payable once a year.
To determine if you should send your self-employment tax quarterly, you should see if you expect the following conditions to apply to you:
- You will owe at least $1,000 in federal income taxes after accounting for your withholding and refundable credits
- Your refundable credits and withholding will cover less than 90% of your tax liability for this year or 100% of your tax liability for the previous year
If you don’t pay your self-employment tax throughout the year and make one payment annually, you may find yourself having to pay interest and penalties on what the IRS will consider late payments.
To avoid these extra expenses, it’s important that you properly estimate your tax liability and determine the right frequency to make payments.
To make payments, you need to ensure you have a Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN).
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Self-Employment Tax FAQ
Why do I have to pay self-employment tax?
Individuals earning over $400 per year through self-employment activities are required to pay self-employment taxes.
For employees that work for a company, their employer will withhold the necessary sums from the employee’s paycheck to remit to the authorities.
However, self-employed individuals are required to calculate their own self-employment tax and remit it directly to the authorities.
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How much self-employment tax do I have to pay?
Self-employment tax is a federal tax that is equivalent to 15.3% of your self-employment net earnings.
In essence, 92.35% of your net earnings is subject to self-employment tax where 12.4% goes to fund Social Security and 2.9% funds Medicare.
Self-employment tax is payable for earnings up to $147,000 where this amount was $137,700 in 2020 and $142,800 in 2021.
What is the difference between self-employment tax and income tax?
The main difference between self-employment tax and income tax is that self-employment tax specifically refers to the federal taxes paid by self-employed individuals to Social Security and Medicare whereas income tax refers to all taxes that individuals or businesses are required to pay.
Self-employment tax can be viewed as a subset of income tax that is broader in scope.
Also, self-employment taxes are paid by sole proprietors, members of a partnership, or business owners whereas income tax can be paid by individuals or entities.
Am I exempt from paying self-employment tax?
Most people earning an income are required to pay self-employment taxes.
However, there are some exceptions to this rule.
You are exempt from paying self-employment taxes if you earn less than $400 in a year or you earn less than $108.28 as a church employee.
Takeaways
So there you have it folks!
What is the self-employment tax?
In a nutshell, self-employment tax is a term used to refer to the amount self-employed individuals and small business owners must pay for Social Security and Medicare.
Individuals earning more than $400 in a year or church employees making more than $108.28 in a year are required to pay self-employment taxes.
To determine how much must be paid, you’ll need to use Schedule SE of your Form 1040.
This tax can apply to freelancers, contractors, independent contractors, sole proprietors, business owners, individuals with a side hustle, gig workers, members of a partnership, or others.
The total self-employment tax amounts to 15.3% where 12.4% goes to fund Social Security and 2.9% goes to fund Medicare.
Everyone’s tax situation is different so it’s important that you investigate what applies to you and consult a professional if you’re not sure.
Now that you know what self-employment tax is and how it works, good luck with your research!
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Schedule SE (Form 1040)
