An Explanation of Self-Employment Taxes
In your business tax planning, don't forget self-employment tax. Self-employment tax is the tax for Social Security and Medicare paid by business owners. It's the same tax (and the same rate) as taxes paid by employees and employers (called FICA tax), but it's paid in a different way.
Self-Employment Tax: Key Takeaways
- You pay self-employment tax each year based on your income from your business as a self-employed person.
- The good news is you don't have to pay this tax if you don't have a profit in your business for the year.
- The bad news is you don't get Social Security/Medicare credit for benefits for the year if you don't have a profit and pay the tax.
The Self-Employment Tax Rate
The self-employment tax calculation is 15.3% of your net business income. There are two parts to this rate:
- Social Security: 12.4%. This amount is capped a maximum amount each year.
- Medicare: 2.9%. If your annual income from employment and self-employment is over a certain amount, you must pay an additional Medicare tax of 0.9% on that income.
Which Business Types Pay Self-Employment Taxes
Self-employment tax is due on the income of all small businesses. All of these businesses are considered pass-through entities because the profits and losses of the business pass through to the owners on their personal tax returns. The business owner calculates their share of net income (income minus expense deductions) from the business for that year and includes this income on their personal tax return.
Pass-through business types include sole proprietors (like independent contractors and freelancers), partners in partnerships, S corporation owners, and limited liability company (LLC) owners. Owners of corporations are shareholders, and they don't pay self-employment tax because they aren't self-employed.
How the Self-Employment Tax Is Calculated and Paid
Step 1: Calculate Business Net Income
Let's assume you are calculating your business taxes on Schedule C of your personal tax return. This form begins with your total earnings, then deducts various allowable ordinary and necessary business expenses. The resulting number is your taxable or pass-through net income from self-employment that will be used in your calculation.
Step 2: Calculate Self-Employment Tax on Schedule SE
This net income is then used to calculate the amount of self-employment tax you owe for the year using Schedule SE. The calculation can be complicated, and there are several ways to run it, using a short-form version or a long-form version.
Schedule SE includes a deduction for one-half of the self-employment tax. You take this deduction to reduce your adjusted gross income (AGI) before calculating your total tax bill. This deduction helps offset the issue of business owners having to pay the entire amount, while employees only need to pay half. (See the employment tax section below.)
Step 3: Include Self-Employment Tax on Your Personal Tax Return
The amount of the tax (minus the deduction) from Schedule SE then carries over from Schedule SE to your personal tax return. Any amount you owe for self-employment tax will be added to your personal tax liability for the current year to be paid to the IRS.
A Simplified Calculation of Self-Employment Tax
Carlos is a single taxpayer. He has no income other than his business income, so he can use the short form of Schedule SE. He has calculated his business net income on Schedule C as $43,400. (He isn't over the Social Security maximum for the year, and his income isn't over the threshold for the additional Medicare tax.)
- He must multiply this amount by 93.35% = $40,513.90.
- Then he multiplies this amount by 15.3% (the self-employment tax rate). $40,513.90 x 15.3% = $6,198.62. This is the amount of his self-employment tax. But, he's not done yet.
- He then figures the deduction at 50% of this amount $6,198.62 x 50% = $3,099.13. The other half ($3,099.13) is the amount of self-employment tax he must carry over to his tax return and pay income tax on.
Self-Employment Tax and Estimated Taxes
Self-employment taxes—and income taxes—are not withheld from your income as a business owner. You get paid as a business owner, taking money from the profits. So you may need to make quarterly estimated tax payments to avoid IRS fines and penalties for underpayment of taxes.
Don't forget to include self-employment taxes in your calculations for estimated taxes! Here is more information on how to calculate your estimated tax bill.
What If I Have Both Employment Income and Self-Employment Income?
If you have a paycheck, you have had Social Security/Medicare taxes (called FICA tax), based on their income from their job. The Social Security portion of the tax is 12.4% on incomes up to the annual maximum, and the Medicare portion is 2.9% percent. (That's 15.3%, the same rate as for self-employment tax.) The employer pays half and the employee pays half; the employee half is withheld from the employee's paycheck.
If you have both employment and self-employment income, the two are considered together for several purposes:
- It ensures Social Security is stopped at the maximum for the year.
- It ensures the Additional Medicare Tax begins at the threshold point
- It allows accurate calculation of the self-employment tax. For this purpose, employment income comes first, then self-employment income, up to the Social Security maximum.
You must use the long form of Schedule SE in this case.
Self-employment taxes are complicated, especially if you must file the long form of Schedule SE. This article gives you just an overall basic understanding. Get help from a tax professional to make sure your self-employment tax—and your business tax in general—is complete and accurate.