What Is Self-Employment Tax?
Self-employed people — a group that can include freelancers, independent contractors and owners of small businesses that are unincorporated — are subject to a progressive income tax just like traditional employees. Essentially, this means that both self-employed individuals and traditional employees pay an increasingly higher rate of tax as they make more money. While both groups pay a progressive income tax, there is a notable difference between the tax obligations of self-employed individuals and traditional employees: the self-employment tax.
Per the Federal Insurance Contributions Act (FICA), which was implemented to ensure funding for the Social Security and Medicare programs, workers must pay a tax on all earnings received, and employers must pay a matching tax on those wages. For self-employed workers, this situation results in a double tax — one tax paid as an employee and another paid as the employer. Fortunately, deductions exist for the self-employed that can help reduce their tax burden to a level that compares to that of traditional employees.
Read on to learn more about self-employment taxes and how you should factor them into your personal finance situation if you work for yourself.
What Is the Self-Employment Tax Rate?
Self-employed individuals must pay both the employee and employer obligations, which amounts to a total tax of 15.3% on your gross wages. Fortunately, deductions exist that can considerably reduce the tax burden for the self-employed.
For the 2021 tax year, 6.2% of your gross wages are automatically deducted from each paycheck to fund the Social Security program, and 1.45% of your gross wages from each paycheck are withheld to fund the Medicare program, amounting to a total of 7.65% of your gross wages for your employee tax obligation. Your employer is obligated to match the percentages, contributing 7.65% of your gross wages to meet the employer obligation.
For 2021, the Social Security tax is only applied to the first $142,800 of your taxable income. In contrast, the Medicare tax is applied to all taxable income. An additional 0.9% Medicare tax may apply to self-employment earnings above certain levels.
Who Has To Pay Self-Employment Tax?
According to the Internal Revenue Service (IRS), a self-employed individual is anyone that (1) carries on a trade or business as a sole proprietor or an independent contractor, (2) is a member of a partnership that carries on a trade business or (3) is otherwise in business for themselves. If you are engaged in any of these types of arrangements, you must pay the self-employment tax, assuming either of the following circumstances apply to you during a tax year:
- You had $400 or more in net earnings from self-employment (excluding anything you made as a church employee).
- You had $108.28 or more of net earnings from church employment.
The above guidelines are firm and apply regardless of your age or retirement status.
How Do You File Taxes When You’re Self-Employed?
For self-employed people, filing taxes is an involved process that requires a variety of forms and deductions, as well as the ability to navigate an array of interdependent IRS guidelines. As a result, many self-employed tax filers enlist a tax professional to do the leg work for them.
What Forms Do You Need?
If you like to do things yourself or you enjoy research, use the high-level guidance below as a starting point to figure out what tax forms you may need as a self-employed individual.
- Generally, you use IRS Schedule C to calculate your net earnings from self-employment.
- You use IRS Schedule SE to calculate your self-employment tax obligation.
- The information from IRS schedules C and SE is input into IRS Form 1040, which is your individual income tax return.
In addition to these three key IRS forms, other tax forms may come into play when you’re self-employed. At the top of the list are various 1099 forms, which are used to report income to the IRS. There are nearly two dozen types of 1099s, but those that most often pertain to self-employed individuals include Form 1099-K , Form 1099-MISC and Form 1099-NEC.
What Deductions Can You Make When Self-Employed?
When you are working for yourself, there are many self-employment tax deductions that can benefit you. The most prominent deductions are outlined below.
- Self-Employment Tax
- With this deduction, you can deduct half of your FICA tax from your net earnings when calculating your taxable income. Essentially, this reduces your Social Security and Medicare tax obligation to a level that approximates that of a traditional employee.
- Home Office
- This is a very complex deduction, covering the cost of any workspace expense you incur regularly and exclusively for your business. Essentially, this includes a portion of your rent or home depreciation, utilities, property insurance and expenses for repairs and maintenance.
- Health Insurance Premiums
- If you are self-employed and pay health insurance premiums (and you are not eligible to participate in a plan through your spouse’s employer), you can deduct all of your health, dental and qualified long-term care insurance premiums. In other situations, certain medical and dental expenses above 7.5% of your adjusted gross income may be tax-deductible.
- Other Expenses
- In many cases, you may have deductions that relate to a variety of business-related expenses, including liability insurance, advertising, travel, education, publications, subscriptions, loan interest and charitable contributions.
Do You Need To Make Quarterly Estimated Payments?
Generally, all self-employed individuals who expect to owe more than $1,000 in self-employment tax are required to pay estimated self-employment taxes on at least a quarterly basis. Not doing so can result in hefty penalties.
How to Make Quarterly Payments
The only requirement to make a payment is that you possess a social security number or an individual taxpayer identification number. You can estimate your tax payment requirements with IRS Form 1040-ES. For more information about how to pay your estimated self-employment tax, see Publication 505, Tax Withholding and Estimated Tax.