What is self-employment tax?
There are two components to self-employment tax: Medicare tax and Social Security tax. When you work for someone else as a W-2 employee, your paychecks include deductions for these taxes as Federal Insurance Contributions Act (FICA) deductions. Your employer sends the withheld taxes to the IRS while also making their own employment tax payments.
Self-employment tax consists of both the employee contribution and the employer portion of Medicare and Social Security taxes. This is because self-employed individuals are effectively both employers and employees of their businesses.
Who has to pay self-employment tax?
Almost every small business owner, entrepreneur, freelancer, and independent contractor is required to pay self-employment tax. This is true whether your business is structured as a sole proprietorship, LLC, or a partnership. This 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 in net earnings from self-employment, you are expected to calculate and pay self-employment tax, even if you are already collecting Social Security benefits, which may or may not be taxable.
The IRS offers an interactive tool on their website to help taxpayers determine whether they have income subject to self-employment tax.
How do I know how much I owe in self-employment tax?
Self-employment tax is calculated as a percentage of your income attributable to self-employment. Because self-employed individuals pay both the employer’s and the employee’s portions, current tax law reduces the income subject to self-employment tax by 7.65%. In other words, you pay self-employment tax on 92.35% of your net business profit. For example, if your net profit was $100,000, you would owe self-employment tax on $92,350. Multiply that by the self-employment tax rate to determine your tax obligation.
Some taxpayers are also required to pay an additional Medicare tax. For instance, married individuals filing jointly with $250,000 or more in taxable income, single filers with $200,000 or more, and others above certain thresholds are subject to an additional 0.9% Medicare tax on the excess income.
To determine how much you owe, calculate your net profit or net loss from your business by subtracting deductible business expenses from income. If net earnings total at least $400, use Schedule SE (Form 1040) to calculate your obligation (referring to the instructions for the form, as needed).
Is there an income limit for paying self-employment tax?
The Social Security tax portion of the self-employment tax has an upper income limit, but there is no similar limit for the Medicare portion.
It is also worth noting that if you have more than one source of self-employment income or W-2 income, the net income from all of your businesses and W-2 wages are 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. Employers are allowed to deduct their portion of FICA taxes (7.65%) as a business expense related to having employees. Similarly, as a self-employed taxpayer, you can deduct the employer portion of self-employment tax as a business deduction. So, for example, if you paid 15.3% in self-employment tax, you could take a deduction equal to 7.65% of the income subject to self-employment tax (or one-half of what you paid.) The self-employment tax deduction is reported on Schedule 1 (Form 1040).
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?
If you were an employee working for someone else, your employer would remit your Social Security and Medicare tax withholdings to the IRS throughout the year. However, self-employed persons are not subject to the withholding requirements. Because the income and FICA tax framework is designed as a “pay as you go” system, self-employed persons and small business owners are expected to make estimated tax payments on a regular schedule.
These tax payments include both estimated income taxes as well as estimated self-employment taxes and are typically calculated so that you pay one-quarter of your total estimated tax liability each payment period. Then, when filing your end-of-year tax return, you are responsible for any additional taxes due if you underpaid. If you overpaid because your net income for the year was lower than anticipated, you can expect to receive a tax refund.
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?
Since self-employment taxes are assessed on net income rather than on gross income, one way to lower the amount of self-employment taxes 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 much more. You can claim these tax deductions using Schedule C (Form 1040) if you operate a business taxed as a sole proprietorship.
How do I pay self-employment tax?
Form 1040-ES is designed to help individuals calculate and pay their estimated taxes, including estimated self-employment taxes. This form includes tax vouchers you can use to remit your quarterly estimated taxes if you choose to pay by check or money order.
You can also make your payments to the IRS electronically using the Electronic Federal Tax Payment System (EFTPS). This is a free, secure electronic payment system you can use to schedule payments up to one year in advance.
What happens if I underpay my self-employment tax?
Failure to pay the full amount of self-employment tax you owe can carry significant consequences. And choosing to wait until the end of the year to pay your self-employment tax can also be a costly mistake. Not only would you need to come up with a significant amount of money at that point to pay the taxes owed but the IRS also assesses penalties in most cases for self-employed persons who do not make 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. However, if the amount paid is at least 90% of the amount due for the current year or is 100% of the taxes due for the previous tax year, whichever is smaller, then an underpayment penalty generally does not apply.
There are also certain exceptions for taxpayers who would otherwise owe penalties for underpaying estimated taxes. These include casualty events, disasters, or other unusual circumstances, or 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.
Small business taxes, including self-employment tax rules and obligations, can be complex and nuanced. If you have questions about your small business or taxes, reach out to a Legal Pro for affordable legal information.
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.
