Definition: Self-employment tax is imposed on self-employment income of $400 or more and covers Social Security and Medicare taxes. Self-employment tax applies to income earned as a freelance or independent worker, such as working as a freelancer or consultant.
How does self-employment tax work?
Self-employment tax is imposed on self-employment income and covers Social Security and Medicare taxes. Generally, anyone with a net self-employment income of $400 or more must pay self-employment taxes, considering the fact that these are not withheld from wages as is the case in an employer-employee relationship.
Who owes self-employment tax?
Self-employment tax applies to income earned as a freelancer or independent worker, such as working as a freelancer or consultant, including working in a food delivery app or driving for a delivery service. If the company you work for does not withhold payroll taxes and you are not classified as an employee, your income is typically considered self-employment income, and you will owe self-employment tax.
For example, Social Security and Medicare taxes may be withheld from each paycheck for a full-time graphic designer working at a software company, along with other taxes such as federal income tax. However, if that graphic designer earns $500 a month from freelance work for a local company, they are likely to receive the full amount each month without any amounts withheld. The designer will be responsible for reporting and paying self-employment tax on that freelance income, along with any other taxes. This typically requires them to do so on their own, which often involves making estimated tax payments.
Note: There are income limits for the Social Security portion of self-employment taxes. For 2022, the first $147,000 of net income is subject to Social Security.
Individuals earning an amount over a specified threshold of income, including income from self-employment, based on their tax status may be subject to an additional Medicare tax of 0.9%. For single individuals, this threshold is $200,000, while for married couples filing jointly, this threshold is $250,000.
What is the self-employment tax rate?
The standard rate is 15.3%, which includes a 12.4% Social Security tax and a 2.9% Medicare tax. This tax rate of 15.3% is applied to 92.35% of the net earnings of the self-employed individual, or the amount remaining after any deductions for business expenses.
For instance, if your net earnings are $60,000 from your dog-walking business in 2021, you would calculate 92.35% of $60,000, which equals $55,410. Your self-employment tax would be 15.3% of $55,410, or $8,478.
Self-employment taxes vs. payroll taxes
While self-employment taxes have some unique features for self-employed individuals, it’s not as if these types of taxes came from nowhere. If you’re already working, you’ve paid similar taxes, just in a different way.
In an employer-employee relationship, each party pays half of the Social Security and Medicare taxes, which are collectively often referred to as FICA or payroll taxes. The employee and employer each contribute 7.65% (6.2% for Social Security and 1.45% for Medicare).
While this means that self-employed individuals pay more directly in these taxes than individuals who are employed, the employer’s share means that the total percentage is the same. Additionally, economists have pointed out that employee wages might have been higher had employers not had to pay their share of payroll taxes. From this perspective, an employee could end up in a similar net financial position as a self-employed individual paying the full 15.3% rate.
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For self-employed individuals, there is also a deduction of half of the self-employment tax owed to account for what an employer would have paid. For example, a dog walker with a net profit of $60,000 and a self-employment tax liability of $8,478 can deduct $4,239 to reduce their adjusted gross income to $55,761, aside from any other deductions. This can help them save money on income taxes.
How to Pay Self-Employment Tax
Self-employed individuals generally need to combine these amounts with any income tax owed. They will use these amounts to make estimated tax payments, typically four times a year based on the quarterly deadlines set by the IRS. For 2022, the dates are April 18, June 15, September 15, and January 17, 2023.
You may use last year’s tax return as a guide to estimate the amount owed in estimated tax payments. However, if you are new to self-employment income or have earned significantly more or less than previous years, you might want to use Form 1040-ES to calculate your quarterly payments. You may also want to seek advice from a tax professional. This way, you can reduce the risk of underpayment penalties or paying significantly more than budgeted when filing your annual return.
Frequently Asked Questions (FAQs)
What is self-employment tax?
Self-employment tax is the total of Social Security and Medicare taxes and is 15.3%. Of that, the Social Security tax rate is 12.4% (6.2% for the employer and 6.2% for the employee), while the Medicare tax rate is 2.9% (1.45% for both the employer and employee).
How to calculate self-employment tax?
Self-employment tax applies to net earnings of $400 or more. You can calculate self-employment tax at 15.3% on 92.35% of your net earnings, or the amount remaining after any deductions for business expenses.
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Sources:
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we verify facts and maintain the accuracy, reliability, and quality of our content.
IRS. “Topic No. 554 Self-Employment Tax.”
IRS. “Self-Employment Tax (Social Security and Medicare Taxes).”
IRS. “Questions and Answers on the Additional Medicare Tax.”
IRS. “Topic No. 751 Social Security and Medicare Rates for Employees and Employers.”
Center on Budget and Policy Priorities. “Policy Basics: Federal Payroll Taxes.”
IRS. “Form 1040-ES for 2022: Estimated Tax for Individuals,” page 3.
Source: https://www.thebalancemoney.com/what-is-self-employment-tax-5221884
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