Self-Employment Tax: Everything You Need to Know
You are subject to self-employment tax if you're a freelancer, own your own business, or are an independent contractor.10 min read
What is Self-Employment Tax?
You are subject to a self-employment tax if you're a freelancer, own your own business, or are an independent contractor. This is the self-employed version of Social Security and Medicare taxes paid by employees and employers. Starting in 2016, you might have to pay 15.3 percent of your income to the Internal Revenue Service.
Why is Self-Employment Tax Important?
It's important for self-employed persons to know how much self-employment tax — also known as the Self-Employment Contributions Act (SECA) tax — they owe.
As an employee, you pay 6.2 percent in taxes for Social Security and 1.45 percent for Medicare. This is known as the Federal Insurance Contributions Act (FICA). Your employer pays the same amount of 7.65 percent for a total of 15.3 percent. Because you are both the employer and employee, you're subject to these taxes. This totals 12.4 percent for Social Security and 2.9 percent for Medicare.
Earned income up to $118,500 is taxable, and all your earned income is subject to Medicare taxes. If you run a business on the side along with a full-time job, you're still only taxed on $118,500 of your earnings for Social Security tax. If you made more than $200,000 filing single status, $250,000 married and filing jointly, or $125,000 married and filing separately, you owe an extra 0.9 percent Medicare tax. This is only on the amount above these thresholds.
You might pay self-employment tax if you earn:
- Income from a home-based business
- Untaxed income
- Income from freelance work
- Income from work as an independent contractor
- Income from an owned business, unless you've deducted payroll taxes
Depending on your earnings, you could owe upwards of 16.2 percent of your income.
Self-Employment Tax Based on Your Entity
Before you calculate and file your self-employment tax, note that different business entities have different tax rules.
- Sole Proprietor
- If you are a sole proprietor, income and expenses should go on your Schedule C. You're responsible for paying self-employment tax for Social Security and Medicare.
- If you are a partnership, the business doesn't pay income tax. Instead, you file an information return such as Form W-2, Wage and Tax Statement. Then use a Form 1041 (Schedule K-1) to report partnership income to the IRS.
- Limited Liability Corporation (LLC)
- C Corporation
- Filing as a C Corporation for small business is rare. However, it provides great tax benefits. Unlike a partnership or sole proprietorship, a C Corporation is taxed as a separate entity from its owners. Profits are taxed at a corporate level but can apply for many special deductions. Tax also applies to shareholder distributions.
- S Corporation
- Taxes for S Corporations are similar to personal income tax. Like a C Corporation, they can set a salary and withhold payroll taxes at the end of the year. You might receive a W-2 at the end of the year that shows your income from an S Corporation.
- An advantage of an S Corporation is that owners can receive a salary. Taking too low of a salary, however, might cause serious tax problems, as wages are the only income the IRS can add to a payroll tax.
How Do I Report Self-Employment Tax?
If you haven't incorporated and you aren't listed as a sole proprietor, filing a self-employment tax is straightforward. You record your business operations on a Schedule C and file it with a Form 1040, U.S. Individual Income Tax Return. Then, you calculate your self-employment tax using a Schedule SE. This sets your income tax apart from self-employment tax.
When figuring your self-employment tax, you can cut your self-employment income by half of the self-employment tax rate. You can also claim half of what you pay in self-employment tax as a deduction in income tax.
How Can I Lessen the Blow and Prepare Myself for Self-Employment Tax?
Paying a giant lump sum at the end of the fiscal year is a blow to anyone's bank account. However, there are ways to reduce this amount for your small business.
- Use 50 percent to 57 percent of the self-employment tax you pay as a deduction from the taxable income on your 1040.
- Make Quarterly Payments
- The best way to protect yourself from a huge amount of taxes is to make quarterly payments, or estimated taxes. To calculate these payments, estimate the amount of money you believe you'll make and divide by four. While these aren't necessary, not paying them might result in interest penalties depending on how long you've waited to pay.
- Quarterly payments should include estimated self-employment tax and income tax.
- The threshold for paying estimated taxes is $1,000 annually after all other withholding. If your withholding will cover 90 percent of your total tax liability, then you are not subject to estimated tax payments.
- Get a Tax ID Number (TIN)
- It's free to get. It also comes in handy if a customer needs a Form W-9.
- Home Office Deduction
- If you work from home, consider using part your home solely for business. Based on the size, you'll qualify for a deduction on your self-employment taxes.
- You should prepare a diagram and measurements of your home office in case of an audit.
- Mortgage interest, home depreciation, property taxes, utilities, homeowner's insurance, and maintenance are all deductible as a percentage of the size of your office compared to the size of the home.
- Using the standard home office deduction method requires you to measure your office to calculate deductions.
- Using the simplified option lets you multiply an IRS calculated rate ($5 per square foot) by your office's square footage. In this case, the home office can be no bigger than 300 square feet.
- Use Apps
- Many finance apps have organizational tools perfect for the self-employed. This allows you to keep your personal and business expenses separate. Other websites also provide many services and products for new businesses.
- Vehicle Depreciation Deductions
- Vehicles over 6,000 pounds qualify for more deductions.
- Maintain a mileage log when using the vehicle for business. In 2016, the tax deduction is 54 cents per mile.
- Maintenance might also be eligible for a tax deduction. This includes oil changes, registration fees, and other operating expenses.
- Office Supplies Deductions
- If you use office supplies for your business, you can deduct computers, electronics, paper, and other items.
- Sales Tax Considerations
- If you sell a good, you're liable for the sales tax. These rates change from state to state and between local municipalities. Make sure to collect these taxes during the sale of goods. Otherwise, you're on the hook at the end of the fiscal year.
- Use Tax Considerations
- If you bought items for your business out-of-state and didn't pay sales tax on them at the time, you're responsible for paying a use tax on those items.
- Payroll Tax Considerations
- If you have employees, you must pay the federal government a payroll tax.
- Interest on business loans and business credit cards are tax-deductible. However, it's usually cheaper to spend money you have rather than rely on interest deductions.
- If you subscribe to a publication to gain valuable insight for your business, you might be able to deduct this cost.
- Contributions to Savings Plans
- Perhaps the best way to lower your taxable income is through savings plans. SEP IRAs, traditional IRAs, and solo 401(k)s reduce your tax bill. In addition, they allow tax-deferred investment gains later. For the 2016 tax year, it's possible to contribute up to $18,000 to savings plans and $24,000 if you're 50 or older. You can also include an extra 25 percent of your self-employment earnings after deducting one-half of the self-employment tax.
- Reducing Taxable Income
- Another way to reduce taxable income is to use a Schedule C. This form allows you to deduct business expenses. Calculate this by subtracting your expenses from your net income. The lower this amount, the less you pay in self-employment tax.
- Other Deductions
- Other common deductions include internet bills, phone bills, shipping, and office rent. For internet and phone, you can only deduct the portion used for business.
- Health Insurance Premiums
- If you're self-employed, pay insurance premiums, and do not take part in your spouse's health plan, you can deduct all premiums from your self-employment tax.
- Meals and Entertainment
- If you're on a business trip or entertaining a client, you can deduct 50 percent of the meal cost.
- Entertaining a business partner might fall under a deduction. You must conduct business immediately before, during, or after the event. These events are also 50 percent deductible.
- Travel Expenses
- Any travel used for business is eligible for a tax deduction. This includes costs to get to a destination, car rental, cab fares, lodging, and meals. One hundred percent of travel expenses are tax-deductible.
- Education Expenses
- You can deduct education expenses only for learning skills related to your business. If it's a skill for a different line of work, it's not tax-deductible. For example, if you run a music lesson business, classes on jazz guitar are tax-deductible. Swim classes aren't.
Self-Employment Tax Example
If your business made $80,000 last year, you should first deduct the 7.65 percent or multiply 80,000 by 92.35 percent. This equals $73,880. Multiplying this number by the 15.3 percent (0.153) self-employment tax rate produces $11,303 for your total self-employment tax. Half of this is deductible from your 1040.
Why Am I Considered Self-Employed and Not an Employee?
This depends on three things:
- Behavior control determines how a company gives you work.
- Financial control determines who has the right to control the business and financial portions of your job.
- Type of relationship
For a W-2 form (employee):
- The business controls the work you do and how it's performed. You also receive supervision and training.
- The company controls all aspects of the finance and business operations.
- The relationship is expected to be long-term. You might also receive benefits.
For a Schedule K-1 (business owner) or Form 1099-MISC (freelancer/independent contractor):
- You control how and when you work.
- You can control the financial aspects of your job. You can incur a loss, you don't pay taxes, and you might also have to invest in the business, take on unreimbursed expenses, and set your own rates and services.
- The types of services you provide are not essential for the hiring business. It's not permanent, and you might not receive benefits.
Employee Taxes vs. Self-Employment Taxes
- Income reported on a Form W-2.
- Taxes withheld on Form W-4.
- Extra taxes might be paid with a tax return and Form 1040.
- Self-Employed Business Owner
- Income reported on a Schedule K-1 or an 1120 business tax return if it's a corporation.
- Taxes paid quarterly based on estimates.
- Forms to file include a Form 1040, Schedule C, Schedule C-EZ, or Schedule SE.
- Self-Employed Independent Contractor or Freelancer
- Income reported on a 1099-MISC.
- Taxes paid quarterly based on estimates.
- Forms include a Form 1040, Schedule SE, Schedule C, or Schedule C-EZ.
You are considered a business owner if you:
- File an 1120 business tax return based on your Schedule K-1.
- You are a member of a business partnership.
- You are a sole proprietor.
- You are in business for yourself either full-time or part-time.
Examples of independent contractors include:
- Dentists and doctors
- Tradesman (electricians, carpenters, etc.)
- Lawn care providers
- Child care providers
- Freelance writers
- Web designers and graphic artists
Hobby vs. Self Employment
If you have a hobby that produces some type of income, you can file it under "other income" on your tax return. However, this doesn't mean you are self-employed. Self-employment is a trade or business that's sole goal is to turn a profit. Even if the business nets a loss, it's still considered self-employment.
Questions About Self-Employment Tax
- Do I have to pay self-employment tax?
Any income that didn't have payroll taxes withheld, didn't result from investments, and didn't come from passive sources is all considered self-employment income. If you received a Form 1099 or no tax forms, you owe self-employment tax.
- How much do I have to earn to be subject to a self-employment tax?
If your income was $400 or more, or if you earned at least $108.28 as a church employee, you must pay self-employment tax. Using an IRS Schedule C or C-EZ will help you determine your net income. You can use a Schedule SE to report these earnings on your 1040.
- Is there any way around paying self-employment tax?
Not legally. However, you can deduct your employer's portion of self-employment taxes (7.65 percent) before multiplying your income by 15.3 percent to determine your self-employment profits. You might also deduct any business expenses that lower your taxable income. You can deduct anything you bought for business purposes (trips, car, furniture, office supplies).
- Do I still need to pay income tax?
Yes. Self-employed persons are subject to both a self-employment tax and income tax.
- What's the difference between FICA taxes and self-employment taxes?
FICA taxes cover Social Security and Medicare. Self-employment taxes do, as well. The only difference is that FICA is paid by employees. Self-employment taxes, or SECA, are paid by a freelancer, independent contractor, or business owner.
- When do I pay estimated taxes?
Quarterly tax payments are on time if postmarked by the due date. If this date falls on a weekend or holiday, the next business day is acceptable. Quarterly estimated tax payments are made:
- April 15 based on income from January 1 to March 31
- June 15 based on income from April 1 to May 31
- September 15 based on income from June 1 to August 31
- January 15 of the following year based on income from September 1 to December 31
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