Self Employment Tax: Definition, How It Works & How To File?

Self employment tax consists of a combination of Social Security and Medicare taxes. If you work as a freelancer, small-business owner, or an independent contractor, you will need to pay self-employment taxes. You will need to pay self-employment tax for your profits only. In general cases, the tax rate for self-employment is 15.3%, where 12.4% is for social security, and 2.9% is for Medicare.

In this article, you will learn some of the essential details about self-employment tax and who is eligible to pay self-employment tax to the IRS. In the following section, we will discuss how the self-employment tax works. Finally, you will be able to learn how to calculate self-employment taxes and how to deduct them. Hence, to learn in detail about self-employment taxes, read on through to the end of the article.

What Is A Self Employment Tax?

According to Investopedia,

“The term self-employment tax refers to taxes self-employed individuals and small business owners pay to the federal government to fund Medicare and Social Security. The self-employment tax is similar to Federal Insurance Contributions Act (FICA) tax paid by employers.”

You have to compute (with or without the help of a tax professional) and report your self-employment taxes on the IRS Form 1040 Schedule SE.

A self-employment tax is quite different from the payroll tax that employees who work for an organization pay the IRS. The difference between self-employment taxes and payroll taxes is that in the case of the latter, the employees and the employers split the tax bill. In the case of self-employed individuals, they will need to pay for both ends.

Who Pays Self-Employment Tax?

You are eligible to be considered a self-employed individual if you have received a 1099 form from someone whom you have worked for. No matter how old you are, the tax rules apply to all. This also holds true even if you are receiving your Social Security benefits or if you are currently under Medicare.

However, if your net income from your self-employment is less than $400 in a tax year or $108.28 or less in a tax-exempt church, you will not need to pay your self-employment tax. If your income is higher than these thresholds, you will need to pay self-employment taxes.

Self-Employment Taxes For 2023

If you are self-employed, you will have to pay 15.3% of your net earnings (profits) to the IRS. The tax rate is a combination of the Social Security tax of 12.4% and the Medicare Tax of 2.9%. Note that the percentage only applies to net earnings and not gross earnings. This makes the self-employment tax different from income tax.

For the year 2023, the first $160,200 of earnings is meant for Social Security. On the other hand, a 0.9% additional Medicare tax applies if your self-employment earnings are more than $200,000 (for single filers) or $250,000 (for joint filers).

However, make sure that you discuss your tax liabilities with a notable tax professional before you consider paying your self-employment taxes.

How Does Self-Employment Tax Work?

According to IRS.gov,

“If you use a tax year other than the calendar year, you must use the tax rate and maximum earnings limit in effect at the beginning of your tax year. Even if the tax rate or maximum earnings limit changes during your tax year, continue to use the same rate and limit throughout your tax year.”

To figure out your net earnings from your self-employment, you will need to use Schedule C of the IRS Form 1040 (only if you are self-employed as a sole proprietor or an independent contractor). However, as per the rules of the IRS, a member of a partnership that does trade or business is also considered self-employed.

The Schedule SE helps you to calculate how much self-employment tax you owe to the IRS. Furthermore, while you pay the tax, you will need to provide your individual taxpayer identification number (TIN) as well.

Basically, the self-employment tax is meant for workers who are self-employed and do not pay withholding taxes like employees. It is necessary to pay self-employment taxes for self-employed individuals so that they receive Social Security benefits once they retire.

The best part about self-employment taxes is that the payment is based on the pay-as-you-go method. Hence, you will need to wait until the annual tax filing deadline, in which case, you will have to pay a penalty for your late payments.

How To Calculate Self-Employment Tax And Tax Deduction?

Your self-employment tax is only applicable to your net earnings and not your gross earnings. You will not need to pay for all your net earnings as self-employment taxes apply to 92.35% of your net earnings. Once you have determined this number, apply the tax rate of 15.3%.

Only the first $160,200 of your earnings, or 15.3%, is eligible for taxation, whichever is less. If you have incurred a loss, consider using Schedule SE to calculate your net earnings.

Here is what Nerdwallet.com informs about tax deductions –

“You can deduct half of your self-employment tax on your income taxes. So, for example, if your Schedule SE says you owe $2,000 in self-employment tax for the year, you’ll need to pay that money when it’s due during the year, but at tax time, $1,000 would be deductible on your 1040.”

Apart from that, there are some other sweet tax deductions as well, such as the qualified business income tax deduction, which lets you deduct tax up to 20%.

Final Thoughts

The self-employment tax is applicable for those individuals and businesspersons who do not pay other withholding taxes. Some self-employment individuals include freelancers, sole proprietors, and independent contractors. The tax payments are mostly for Social Security and Medicare.

To report your self-employment tax, you will need to fill out the IRS Form 1040 Schedule SE. If you earn less than $400 (or less than $108.28 from a church), you will not need to pay the tax. Do you have any more recommendations to add regarding how to file self-employment taxes? Share your views with us in the comments section below.

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