Self-Employment Tax

Being self-employed allows more flexibility in terms of what type of work you do, how you do it, where you work, and who you work with. While all of these things give self-employed individuals a certain level of freedom compared with employees in a structured work environment, being self-employed does not make you free from tax obligations. Today, let’s talk about self-employment tax and how it affects self-employed individuals. 

What is “self-employment tax”?

Self-employment tax refers to the federal tax paid by self-employed individuals. When we talk about self-employment tax, we refer to Social Security and Medicare taxes in particular and not income tax or any other tax. 

Who is required to pay self-employment tax? 

Self-employment tax is paid by self-employed individuals. How do you know if you are self-employed? Check if any of the following circumstances apply to you: 

• You are a sole proprietor
• You are an independent contractor
• You are a member of a partnership for a trade or business
• You are in business for yourself including a part-time business

What is the self-employment tax rate? 

Self-employment tax is the sum of both Social Security and Medicare taxes. For self-employed individuals, the Social Security and Medicare taxes that they pay are higher compared to regular employees. If you are wondering why this is the case, the reason is that, in a company, employees and employers share Social Security and Medicare taxes. There is an employer share and employee share. However, self-individuals have to pay the entire amount on their own.

According to federal law, the self-employment tax rate is 15.3% of net earnings. Let’s break it down:

• Social Security tax: 12.4%
• Medicare tax: 2.9%
• Total Self-employment tax rate: 15.3%

The Social Security tax limit for 2021 is $142,800. This means that Social Security tax is only due on the first $142,800 of net earnings. For Medicare tax, 2.9% is applicable regardless of the amount of net earnings. Furthermore, you are required to pay an additional Medicare tax of 0.9% if your net earnings exceed $200,000 for single filers, $250,000 if married and filing jointly, and $125,000 if married and filing separately. 

I am a self-employed individual. Is there a minimum amount of earnings that I must earn to pay self-employment tax?

Self-employment tax is due if your net earnings from being self-employed are $400 or more. For a tax-exempt church, they are required to pay self-employment tax for earnings of $108.28 or more during the tax year. If the earnings of a self-employed individual are less than these aforementioned values, they do not have to pay self-employment tax. 

How is self-employment tax calculated? 

Before calculating self-employment tax, you first need to find out your net profit or net loss by using IRS Schedule C. You can do this by taking note of your business income and subtracting from it your business expenses. If your business expenses exceed your business income, the difference is called a net loss. If your business expenses are less than your business income, the difference is called net profit. 

Once you’ve determined your net earnings, use IRS Schedule SE to figure the self-employment tax due. 

Self-employment tax is considered a tax-deductible expense. The IRS allows 7.65% (this is half of the 15.3% self-employment tax rate) as a business deduction from your net earnings which can help in reducing the tax due. 

Self-employment tax must be paid by quarterly estimated tax payments. Form 1040-ES contains blank vouchers that can be used when mailing estimated tax payments. Another method is using the Electronic Federal Tax Payment System (EFTPS).