What is self-employment tax?
Self-employment tax consists of both the employee and the employer portions of Medicare and Social Security taxes. Self-employed individuals, however, are effectively both employers and employees of their businesses, so they must pay both portions.
For example, when you work for someone else, they withhold what you owe in taxes from your earnings and they also pay additional taxes. When you are self-employed, there is no one else withholding these taxes and so you must pay all the taxes yourself. Additionally, you are required to file personal taxes, which may include your business taxes if those are not filed separately.
Who pays self-employment tax?
Almost every small business owner, entrepreneur, freelancer, and independent contractor pays self-employment tax.
This is true whether your business is structured as a sole proprietorship, LLC, or a partnership where you are not a W-2 employee or receive income beyond your W-2 wages. This self-employment tax obligation applies even if you do not have a formal business entity set up for your income (for example, gig workers and those with part-time or seasonal side income).
If you earn at least $400 from your self-employment, you are expected to calculate and pay self-employment tax, even if you already collect Social Security benefits.
How do I pay self-employment tax?
Self-employed individuals are required to pay estimated quarterly taxes. Calculating how much to pay in estimated taxes can be complicated, especially for individuals who are new to the process, or had significant changes in income.
Form 1040-ES is designed to help individuals calculate and pay their estimated self-employment taxes. This form includes tax vouchers you can use to mail your quarterly estimated tax payments, or you may pay electronically using the Electronic Federal Tax Payment System (EFTPS).
Save money when you file self-employment taxes
Self-employment taxes are calculated based on your net profits from self-employment. Generally, you can lower your taxes by deducting your business expenses when filing your taxes. Common deductible business expenses may include:
- Office supplies, software, and equipment.
- Travel and vehicle expenses.
- Office rent and insurance.
- Legal and professional expenses.
Many other types of expenses may be deductible for your specific business.
What is the self-employment tax rate?
The self-employment tax rate is 15.3%, which is made up of 12.4% for Social Security and 2.9% for Medicare. High earners may also owe an additional 0.9% Medicare tax on compensation above the filing-status thresholds.
If you were employed by someone else, your employer would pay 6.2% in Social Security and 1.45% in Medicare taxes, and you would pay the other 6.2% for Social Security and 1.45% for Medicare taxes through withholdings from your paycheck.
Because self-employed individuals are required to pay both the employer’s and the employee’s portion of Social Security and Medicare taxes, current tax law reduces the income that would otherwise be subject to self-employment tax by 7.65%. In other words, you only pay self-employment tax on 92.35% of your net business profit.
Some higher-earning taxpayers are also required to pay an additional Medicare tax of 0.9%. This additional Medicare tax is only applicable to compensation that exceeds the applicable income threshold.
How do I know how much I owe in self-employment tax?
Self-employment tax is calculated from 92.35% of your net business profits attributed to self-employment.
For example, if your net business profit was $100,000, you would owe self-employment tax on $92,350. To determine your obligation, you would multiply that by the 15.3% self-employment tax rate, which means you would owe $14,129.55.
Are taxes higher if I’m self-employed?
Self-employed business owners are subject to the same income tax brackets as people who are employed by other businesses. Entrepreneurs, however, must pay both the employer and employee portions of their employment taxes on their self-employment earnings. In this respect, self-employed individuals pay higher taxes than people who work for other companies.
Self-employment taxes include Medicare and Social Security taxes. Everyone must pay these taxes. Individuals who earn wages from an employer have taxes deducted from their regular paychecks to pay the employee portion of Medicare and Social Security taxes, and their employers pay the other one-half of these taxes. Self-employed persons are responsible for the entire 15.3% of the first portion of their earnings subject to Social Security tax.
What types of tax deductions can I use if I’m self-employed?
Self-employed persons may benefit from a variety of tax deductions for expenses directly related to their business. To qualify as deductible, claimed expenses must be deemed both ordinary (customary for the type of business) and necessary.
Small business owners and entrepreneurs may be able to deduct expenses associated with:
If you borrowed money for business purposes, you can generally deduct interest paid on such loans, as well as taxes paid for the business. For any items acquired or used for both business and personal use, your tax deduction will be limited to the portion related to the business. There are many deductions available for business owners and entrepreneurs, depending on their specific situation.
- Office or retail space.
- Vehicles used for business purposes.
- Equipment and technology.
- Materials and supplies.
- Payroll.
- Business retirement plans, and more.
Is there an income limit for paying self-employment tax?
You are generally required to pay self-employment taxes if you had net profit from self-employment of $400 or more. The Social Security portion applies only up to the annual Social Security wage base set each year; the Medicare portion (2.9%) has no cap, and higher earners may also owe the 0.9% Additional Medicare Tax on compensation above the filing-status thresholds.
For example, if your self-employment net income is above that limit, you would only pay the Social Security portion on that capped amount. The full amount of your earnings, however, is still subject to the 2.9% Medicare portion of the self-employment tax, because there is no upper limit for Medicare tax. Higher earners may also owe the additional 0.9% Medicare tax on income exceeding the applicable threshold.
If you have more than one source of earned income, all of your earned income is added together when determining whether you are over the maximum income threshold for Social Security tax.
Can I take a business tax deduction for the self-employment taxes?
Yes! You can deduct one-half of your self-employment tax as an above-the-line deduction on Form 1040 (calculated on Schedule SE and carried to Schedule 1). This deduction does not apply to any Additional 0.9% Medicare Tax.
This is an “above the line” deduction, meaning that it is deducted from gross income for purposes of calculating adjusted gross income on IRS Form 1040.
Do I pay self-employment tax in April when income taxes are due?
Estimated tax payments from self-employment are calculated so that you pay one-quarter of your total annual tax liability each payment period. Then, when filing your annual tax return, you pay any additional taxes due if you underpaid, or receive a tax refund if you overpaid.
Quarterly tax payments are generally due as follows:
- April 15 for January 1 to March 31.
- June 15 for April 1 to May 31.
- September 15 for June 1 to August 31.
- January 15 of the following year for September 1 to December 31.
When one of these due dates falls on a weekend or holiday, it is moved to the next business day.
Are there ways to lower my self-employment tax bill?
Unfortunately, self-employment tax represents a significant tax burden for small business owners. Because the taxes are assessed on net income rather than on gross income, one way to lower the amount you pay is to claim all of the tax deductions for which you are eligible.
There are many available small business tax deductions that can lower the amount of net income and, ultimately, the amount of self-employment taxes you owe. You may be eligible to take deductions for a home office, utilities, marketing, supplies, postage, and more. Claim these tax deductions using Schedule C (Form 1040).
What happens if I underpay my self-employment tax?
Failure to pay the full amount of self-employment tax you owe, or waiting until the end of the year to pay your self-employment tax, can carry significant consequences. The IRS assesses penalties, in most cases, for self-employed persons who underpay quarterly estimated tax payments.
If you owe more than $1,000 in taxes at the end of the year after subtracting amounts withheld or otherwise paid throughout the year, you could be subject to a penalty for underpayment of your estimated taxes. If the amount paid, however, is at least 90% of the amount due for the current year or 100% of the taxes due for the previous tax year, whichever is smaller, then an underpayment penalty generally does not apply.
There are some exceptions. These include casualty events, disasters, or other unusual circumstances. Also, there is an exception for persons who were at least age 62 and retired or became disabled during the tax year when estimated payments would have been due and there was reasonable cause for the underpayment.
What happens if I don't pay self-employment taxes?
The income tax system in the U.S. is a “pay-as-you-go” system, whether you are employed by someone else or are self-employed. If you do not pay your self-employment taxes or underpay your taxes, you may also have to pay penalties and interest. The penalties and interest can add up and compound over time, and lead to other financial consequences.
Making quarterly payments can often be a challenge for self-employed workers; however, it is often better than facing a large tax bill at the end of the year that includes penalties and interest. If you have fallen behind on your taxes, the IRS frequently allows individuals to catch up through payment plans.
Do I need to pay quarterly estimated business taxes?
Knowing what taxes you'll need to pay and when can be confusing. Generally, self-employed individuals and small business owners need to pay quarterly estimated business taxes. If you don't pay or if you underpay, you may end up paying penalties and a large tax bill when you file your annual taxes.
The general guideline is that if you expect to owe over $1,000 in taxes by the end of the year, you should pay estimated quarterly taxes. Corporations are expected to make quarterly tax payments if they expect to owe $500 or more in taxes at year end. Additionally, if you paid more than zero the year before, you may also be expected to pay quarterly taxes.
To be on the safe side, you should pay quarterly taxes unless it is your first year of business and you do not expect to make a profit. You can pay your estimated taxes online or by mail. To calculate your estimated taxes from self-employment, use Form 1040-ES. Corporations can calculate their estimated taxes using Form 1120-W.
Please note: This page offers general legal information, not but not legal advice tailored for your specific legal situation. Rocket Lawyer Incorporated isn't a law firm or a substitute for one. For further information on this topic, you can Ask a Legal Pro.
