A Guide to Self Employment Tax Form Requirements
6 min. Read
Last Updated: 04/14/2021
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Self-employment tax (sometimes called SE tax) obligations need to be handled properly, otherwise penalties could ensue. If you own your own business or work as a sole proprietor, you'll be responsible for maintaining proof of your income and expenses. At year-end, you'll need to know which self employment tax form requirements apply to you. Here are some basics to help you understand what is required as part of the self-employment tax.
What is self-employment tax?
Businesses with paid employees use the payroll process to withhold taxes and remit them to the government. Self-employed individuals must complete these steps on their own. Estimated taxes can be paid through the year, with a final calculation and payment made when an annual tax form is filed. In addition to income taxes, the self-employment (SE) tax must also be calculated and paid. The SE tax includes the Social Security and Medicare payments typically withheld by employers. If you earned $400 or more in a year as a business owner or sole proprietor, you must pay Social Security and Medicare taxes to the federal government.
Why do I have to pay self-employment tax?
Self-employed individuals do not pay Federal Insurance Contributions Act (FICA) taxes because they do not have wages. Instead, the self-employment (SE) tax was created in 1951 to enable self-employed individuals to build up Social Security (and, starting in 1966, Medicare) credits. Essentially, the SE tax is a combination of the employer and employee share of FICA, applying to net earnings from self-employment tax. Self-employment tax is figured on Schedule SE, Self-Employment Tax, of Form 1040.
What is the difference between income tax and self-employment tax?
Income tax is the amount you pay to the government, based on your annual income, including self-employed earnings. Self-employment tax is a subset of income tax which covers Social Security and Medicare taxes. Employers typically withhold these two amounts from employees' paychecks, but self-employed individuals must calculate and withhold these amounts from their earnings and take on the responsibility of paying the correct amounts each year.
How do I calculate my self-employment tax and what amount of self-employment tax can I expect to pay?
Currently, the rate for the Social Security portion of the self-employment tax is 12.4 percent. The rate for the Medicare portion is 2.9 percent. For example, for 2020, the tax rate of 12.4 percent applies to 92.35 percent of net earnings up to $137,700 (the wage base for the Social Security tax, which increased to $142,800); the 2.9 percent rate applies to all net earnings (there is no ceiling for this portion of the tax). A self-employed individual with earnings (revenue minus deductible expenses) of $150,000 would expect to pay over $20,000 in SE tax.
If a self-employed person also has wages from a job, the wages are coordinated with the SE tax so that the wage-base ceiling can be properly applied. For example, if a person earns $142,800 or more in 2021 from a job and does freelance work as an independent contractor or has a sideline business that's unincorporated, there will be no Social Security tax on net earnings from self-employment because the tax obligation has been fulfilled on the job. Because there is no ceiling for the Medicare tax, net self-employment income above the amount of wages is subject to the Medicare portion of SE tax.
One half of the self-employment tax is deductible from gross income (i.e., on Schedule 1 of Form 1040). This adjusted gross income write-off can be claimed whether or not personal deductions are itemized. It is not subtracted from business income.
There is an additional 0.9 percent Medicare tax on earned income over a threshold amount ($250,000 for joint filers; $200,000 for singles; $125,000 for married persons filing separately). This additional Medicare tax does not impact the amount of SE tax; it is figured separately and added as a tax owed on the tax return. No portion of this additional tax is deductible.
Net earnings from self-employment
The SE tax applies if net earnings from self-employment are $400 or more. Net earnings, which are essentially profits, result from self-employment as a sole proprietor, independent contractor, general partner, and limited liability company (LLC) member (with exceptions explained later). Limited partners are not subject to self-employment tax except to the extent they receive guaranteed payments for services rendered to or on behalf of the partnership.
Net earnings for SE purposes do not depend on what is distributed or retained in the business bank account. More specifically, net earnings are:
Schedule C filers (independent contractors including those working in the gig economy; sole proprietors; one-member LLCs): line 31 of Schedule C, net profit or (loss).
Schedule F filers (farmers): line 34 of Schedule F, net farm profit or (loss).
Form 1065 filers (partners; LLCs with 2 or more members): Schedule K-1 (Form 1065), box 14, code A.
If you have more than one business from which you receive net earnings, you would combine the amount on Schedule SE. If there is a loss in one business, it reduces the net earnings from another that is subject to SE tax.
For spouses filing jointly, each must complete a separate Schedule SE if each has net earnings from self-employment. Spouses who co-own a business and both materially participate in it can elect to treat it as a joint venture (instead of a partnership). For SE purposes, each reports his/her share of net earnings from the business. For spouses in community property states, only the spouse who participates in the business reports the net earnings from it. If both participate, then each pays SE tax on his/her distributive share.
Usually, wages received by employees are exempt from self-employment tax; they are subject to FICA (as explained earlier). This is so even if they are statutory employees who can file Schedule C to report their earnings and business-related expenses.
Special rules for LLC members
Are LLC members treated like general partners subject to SE tax, or limited partners exempt from SE tax? LLC members who are active in the day-to-day operations of their businesses figure self-employment tax in the same way as general partners. To what extent the distributive share of business income for an LLC member who is merely an investor should be subject to SE tax remains unclear. Early in 2017, the U.S. Tax Court stated that an investor in a surgery center owned by an LLC did not owe any self-employment tax on their distributive share. The IRS has put this question on the 2018-2019 Priority Guidance Plan, but there is no definitive guidance on the matter yet.
Optional self-employment tax
Self-employed individuals who earn income below a set amount can elect to pay self-employment tax to accrue Social Security and Medicare credits. There is an optional method for self-employed farmers and another optional method for other self-employed individuals.
And finally, self-employment tax should be considered by self-employed individuals when figuring quarterly estimated tax payments.
When and how do you pay self-employment tax?
Self-employment tax is paid in the same way as federal income tax. Self-employment tax must be taken into account when figuring estimated taxes throughout the year. Failure to pay sufficient taxes (including self-employment tax) via withholding and estimated taxes throughout the year can result in underpayment penalties.
What Self-Employment Tax Forms Do I Need?
Self-employed individuals report income and expenses on their tax returns each year. Some of the forms you may need to file your annual return include the following:
1099-NEC —This self employment tax form will be completed and sent to you by companies you worked for as an independent contractor. 1099-NEC forms are used to report non-employee income which is claimed as earnings from self-employment on your annual tax return.
1099-MISC — If you receive income in the form of rental payments or royalties, it will be reported to you on a Form 1099-MISC.
Form 1040 — The annual tax return reports all income, including self-employment income. Specific schedules for self-employed individuals will need to be completed.
Schedule 1 — This supplemental schedule reports additional types of income as well as adjustments to income, including business income. You will also list the deductible portion of your self-employment tax on this form, which then carries over to the 1040.
Schedule C — This schedule reports profit or loss from a business, including earnings and expenses related to self-employment.
Schedule SE — Calculates self-employment (SE) taxes.
Form 8829 — If you qualify for a home office deduction, this is the form where you will calculate the amount you wish to claim for tax purposes.
To avoid IRS penalties, you may also want to pay estimated taxes throughout the year using Form 1040-ES.
Self-employed individuals must assume the responsibility for documenting business income and expenses for tax purposes to ensure they are remitting the proper amounts to the government at year-end.