Self-Employment Tax: Definition, How It Works, & How To Calculate It
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Last Updated: 12/05/2023
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Self-employment tax (sometimes called SE tax) obligations must be handled properly; otherwise, penalties could ensue. If you own your 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 the self-employment tax.
What Is Self-Employment Tax?
The self-employment tax definition includes amounts paid to the government to meet Social Security and Medicare obligations. While traditional employers pay a portion of these taxes on behalf of their employees, self-employed individuals such as sole proprietors, freelancers, and contractors must pay both employee and employer portions of Social Security and Medicare taxes. Together, these payments are called self-employment (SE) tax. Anyone meeting the criteria for self-employment and earning $400 or more in a year must pay Social Security and Medicare taxes to the federal government.
What Is the Self-Employment Tax Rate?
The 2023 self-employment tax rate equals 15.3% for individuals earning up to $160,200. Social Security tax makes up 12.4% of this total (6.2% for the employee portion and 6.2% for the additional employer portion the self-employed individual pays). Medicare tax equals 2.9% (1.4% for the employee portion and 1.45% for the employer portion paid by the self-employed individual).
Because the Social Security portion of the tax applies only to earnings up to $160,200, the SE tax rate falls to the Medicare-only amount of 2.9% on additional income. Any self-employment income over $200,000 is also subject to an additional 0.9% of Medicare tax.
How Does Self-Employment Tax Work?
Businesses with paid employees will implement a 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 throughout 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.
When completing a federal Form 1040, self-employed individuals will calculate their taxable income using Schedule C. Self-employment tax is calculated separately on Schedule SE. You'll also be able to deduct one-half of your total self-employment tax owed as a business deduction, which will lessen your overall tax liability.
Why Do You Pay Self-Employment Tax?
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. Self-employed individuals do not pay Federal Insurance Contributions Act (FICA) taxes. Essentially, the SE tax is a combination of the employer and employee share of FICA, applied to net earnings from self-employment.
What Is the Difference Between Income Tax and Self-Employment Tax?
Income tax is the amount you pay the government based on your annual income from all sources, 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. In contrast, self-employed individuals must calculate and withhold these amounts from their earnings and be responsible for paying the correct amounts each year.
How To Calculate Self-Employment Tax When Filing Your 1040
You will include Schedule SE with your annual Form 1040 to calculate self-employment tax on your net earnings. More specifically, net earnings subject to SE tax include the following amount:
- 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 two 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 will combine the amount on Schedule SE. If there is a loss in one business, it reduces the net earnings from another subject to SE tax.
You can calculate the self-employment tax once you have totaled your net earnings.
- Enter your net earnings on the Schedule SE and multiply this amount by 92.35% to arrive at the total taxable amount. (The first 7.65% of net earnings is not subject to tax.)
- If earnings are equal to or less than $160,200, multiply the entire amount by 15.3%.
- Multiply any earnings over $160,200 by the Medicare rate of 2.9%.
- Multiply any earnings over $200,000 by 0.9% to account for the additional Medicare tax.
How much is self-employment tax going to cost? An individual filing taxes as self-employed earning $300,000 would calculate their tax as follows:
- $300,000 X .9235 = $277,050 taxable income
- $160,200 X .153 = $24,510.60 Social Security and Medicare Tax
- $277,050-$160,200 = $116,850 Medicare-Only Income
- $116,850 X .029 = $3,388.65 Medicare-Only Tax
- $277,050-$200,000 = $77,050 Additional Medicare Income
- $77,050 X .009 = $693.45 Additional Medicare Tax
Add the three tax amounts ($24,510.60 + $3,388.65 + $693.45) to calculate total self-employment tax of $28,592.70.
You can use tax software to calculate the amounts due or ask your tax preparer to assist with calculating and reviewing your SE tax. And finally, self-employed individuals should consider self-employment tax when figuring quarterly estimated tax payments.
When Do You Have To Pay Self-Employment Taxes?
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.
If you have more than one business from which you receive net earnings, you will 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 their 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, each pays SE tax on their 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 are limited partners exempt from SE tax? According to the IRS, certain LLC members who are active in the day-to-day operations of their businesses may be viewed as self-employed and must calculate SE tax in the same way as general partners. IRS stipulations regarding the distributive share of business income for an LLC member who is merely an investor are less clear regarding the payment of SE tax. If you hold the status of LLC member in a small business, you should consult a tax expert to determine if you must pay self-employment tax related to your earnings.
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.
What Are Tax Deductions for Self-Employed Individuals?
While you must calculate and pay self-employment tax when applicable to your net earnings, you may also be entitled to claim certain tax deductions that lower your tax liability. Generally, half of your self-employment tax may be deducted from income on your Form 1040. Small business owners with pass-through income may also qualify for a qualified business deduction. Other business expenses, such as the cost of advertising, insurance, and work-related travel, may be taken as self-employment tax deductions for federal filing purposes.
Required Self-Employed Tax Forms
Self-employed individuals must report income and expenses on their tax returns each year. Some of the forms you may need to file along with 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 through rental payments or royalties, it will be reported to you on Form 1099-MISC.
Form 1040 — The annual federal 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 and 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 reduce risk of IRS penalties, you may also want to pay estimated yearly taxes using Form 1040-ES.
Properly Filing Self-Employment Taxes Is Critical
Self-employed individuals must document business income and expenses for tax purposes. Understanding how to file self-employment taxes and remit the proper amounts to the government at year-end is essential. The self-employment tax includes your contribution to Social Security and Medicare. While self-employed individuals must pay amounts typically covered by employers on behalf of their employees, a portion of this tax may be deducted as a business expense. Paychex Payroll Tax Services can help ensure you've filed your self-employment taxes accurately and on time.