How to Calculate and Pay Self-employment Taxes
If you own a business that is not a corporation, you are considered to be self-employed, and you must pay self-employment taxes, based on the net income of your business.
Self-employment taxes are paid to the Social Security Administration for Social Security and Medicare eligibility. If this tax sounds familiar, it's because it's essentially the same as Social Security and Medicare taxes for employees, just with a different name. You pay these taxes on your personal tax return, along with the income tax liability for your business.
Self-employment taxes are not withheld from your income as a business owner. You must figure the amount of the tax and keep track during the year. You may also need to pay estimated taxes to cover the amount of business income tax and self-employment tax you'll need to pay with your tax return.
According to the Internal Revenue Service (IRS), you are self-employed if either of the following applies to you:
- You carry on a trade or business as a sole proprietor; or
- You are a member of a partnership or limited liability company (LLC) that files a Form 1065, U.S. Return of Partnership, that carries on a trade or business.
Basically you are self-employed if you are in business for yourself, including a part-time business.
As usual, there's more to it than this simple statement. You are self-employed if:
- You are an independent contractor or freelancer) working for someone, but not as an employee.
- You receive a 1099-MISC tax report rom someone you do work for.
You are NOT self-employed:
- If you are an owner (shareholder) of a corporation
- For any income you receive that's reported on Form W-2 (the annual tax report for employees).
You can be self-employed in one job and be an employee in another job. See the article below for information on how a dual role affects your self-employment tax.
Self-employment taxes are taxes that every self-employed person must pay, for Social Security and Medicare. it's similar to FICA taxes, Social Security and Medicare taxes that employees pay through payroll withholding.
The self-employment tax rate is 15.3% of your net profit or loss from your business for a year. That means you must figure your business taxes for the year, including income, expenses, tax credits, and other adjustments. The result is your net earnings (the same thing as profit or loss).
This tax rate is similar to the FICA tax rate, but for FICA taxes employees and their employers share the tax.
If you are a sole proprietor, member (owner) of an LLC, or a partner in a partnership, you are considered to be self-employed, and your portion of net income from your business is subject to self-employment tax.
The calculation of net income for your business is done in basically the same way for each of these business types.
If you are a partner in a partner or member of an LLC, you will receive a share of the net income of the business, based on the rules of your partnership. That means your self-employment tax will be based on this income, even if the income stays in the business.
Reporting Self-employment Income and Taxes
Self-employed individuals report their business income on their personal tax return.
- All self-employed individuals calculate and report self-employment tax on Schedule SE.
- Sole proprietors and single-member LLC owners report business net income on Schedule C.
- Partnerships and multiple-member LLCs report business net income on Schedule K-1.
Just to be clear, if you are self-employed, you must pay self-employment tax on the net income of your business, not the money you may take out of the business.
For example, Joe is a 50% partner in a two-person partnership. He took out $34,000 in personal withdrawals during the year, and the business net income for the year is $100,000. Joe must pay self-employment tax on $50,000, not on the $34,000 he withdrew.
Three pieces to the self-employment tax rate:
Base rate. The self-employment tax rate is 15.3% of net income from self-employment, but the Social Security portion of this tax is capped at the Social Security maximum income each year. You must pay self-employment tax and file Schedule SE if your net earnings from self-employment were $400 or more during the year.
Adjustment. The amount subject to self-employment tax is 92.35% of your net self-employed earnings. All of your earnings are subject to the Medicare tax, including the additional Medicare tax for higher-earning individuals.
Employer-equivalent Credit. Half of the amount of the calculated self-employment tax is credited back to the business owner before figuring your adjusted gross income amount on the owner's tax return. The IRS calls this the "employer-equivalent" portion of your self-employment tax. This deduction doesn't affect your net earnings from self-employment or your self-employment tax.
Here's a quick example:
Sara's net income from her business last year was $28,000.
92.35% of that amount is $25,858.
So her self-employment tax for the year is $3,956. (the adjusted rate x 15.3%)
She can also take an "employer-equivalent" deduction of $1,978. (50% of the self-employment tax amount).
So her self-employment tax for the year is $1,978.
This is over-simplified, but you get the idea.
Net earnings are calculated generally by starting with gross income from the business and subtracting deductions, tax credits, and depreciation allowances. This general calculation differs slightly depending on the business type.
If you have more than one business, combine the net earnings or losses for these businesses. A loss from one business can reduce your total net income from both businesses. File one Schedule SE for the combined earnings of both businesses.
Your self-employment tax is calculated using Schedule SE. The net earnings (i.e., profit) from the business are the basis for this calculation.
You have the option of using a short or long schedule, depending on your income level and source of earnings.
Using the short version of Schedule SE:
- Enter your net profit or (loss) from your business, from Schedule C or Schedule K-1.
- Multiply this number by 92.35% (09235).
- If the number is less than $128,400, multiply it by 15.3%.
How Do Self-Employment Taxes Affect My Personal 1040 Tax Bill?
Your self-employment taxes are added to your income taxes on your personal income tax return.
First, calculate the amount of your self-employment taxes, based on your business net income. Then, add these taxes to the total taxes owed. Your total tax bill includes both self-employment taxes and income taxes owed.
Self-employment taxes, like income taxes, aren't withheld from your income as a business owner. So you must pay these taxes at tax time, through your personal tax return.
But he IRS doesn't want to wait until tax time to collect your self-employment tax. You may need to pay self-employment taxes and taxes on your business income quarterly, to avoid penalties. The way to avoid penalties is to pay estimated taxes. You can do a rough calculation and pay these taxes quarterly: April 15, July 15, September 15, and January 15 of the following year.
As a self-employed business owner, it is important to understand your payment obligations in accordance with U.S. tax laws. Make sure that you accurately report and your self-employment taxes so there are no surprises.