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 tax obligations as Federal Insurance Contributions Act (FICA) deductions. Your employer sends the withheld taxes to the IRS for you while 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?
Ultimately, 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 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 are already collecting Social Security benefits, which may or may not be taxable.
The IRS offers an interactive tool on their website designed 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 using a percentage of your income attributable to self-employment. In 2023, the self-employment tax rate is 15.3%, which is made up of 12.4% for Social Security and 2.9% for Medicare. 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. 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, which means you would owe $14,129.55.
Some taxpayers are also required to pay an additional Medicare tax. Married individuals filing joint returns with $250,000 or more in taxable income ($125,000 for married filing separate returns), and single filers, Head of Household filers, and qualifying surviving spouse filers with $200,000 or more in taxable income are subject to 0.9% of Additional Medicare Tax on the amount of compensation that exceeds the applicable threshold.
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?
Any self-employment income you earn greater than $400 is subject to Medicare tax. There is no upper limit beyond which taxes are not owed. However, for the 2023 tax year, the Social Security tax portion of self-employment tax only applies to the first $160,200 of taxable income. This means that the maximum amount of Social Security tax a self-employed person can pay on that income in 2023 is $19,864.80. For 2024, the maximum amount of self-employment income subject to Social Security tax is $168,600, meaning that the maximum self-employment tax amount attributable to Social Security in the 2024 tax year is set to increase to $20,906.40.
For example, if your self-employment net income for 2023 is $200,000, you would pay taxes on $184,700 (again, 92.35% of your net business profit is taxable for self-employment tax purposes). The full amount of $184,700 would be subject to the 2.9% Medicare portion of the self-employment tax, for a total of $5,356.30, because there is no upper limit for taxable income for Medicare tax. However, instead of paying the full 12.4% portion for Social Security tax on the full amount, you would only be responsible for 12.4% of the maximum income subject to Social Security tax. As mentioned earlier, that income limit in 2023 is $160,200, resulting in a maximum Social Security tax of $19,864.80.
It is also worth noting that if you have more than one source of self-employment income, the net income from all of your businesses 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! 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, if you paid the full 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.)
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?
Unfortunately, self-employment tax represents a significant portion of small business owners’ net income. 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 much more. Claim these tax deductions using Schedule C (Form 1040).
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.
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 incredibly complex and nuanced. Get matched with a tax pro via Rocket Tax™ to save time and money filling your tax returns. If you have more questions about your small business or taxes, reach out to a Rocket Lawyer network attorney for affordable legal advice.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.
