As a self-employed individual or sole proprietor, you know there are many challenges associated with paying your taxes. For most workers employed by another company, the necessary federal and state taxes are deducted from their paychecks, taking the onus off of the worker to be responsible for initiating payment themselves.
If you are self-employed, however, then taxes are not typically deducted from your pay for you, which means that it’s your responsibility to make those payments yourself. Here’s an overview of the self-employment tax and what it includes.
What Is the Self-Employment Tax?
It is an umbrella term that encompasses two different taxes:
- Social Security Tax. The Social Security tax is 12.4% of your self-employment earnings up to $118,500. Any amount you make as a self-employed individual over that amount is exempt from this tax.
- Medicare Tax. The Medicare tax is 2.9% of your self-employment earnings. Medicare tax is applied to all of your earnings.
For conventional, W-2 employees, employers pay half of these taxes for said employees, meaning that the employees would only pay 7.65% (half of 15.3%). To ease the burden on self-employed individuals the federal government allows you to calculate your net earnings, reducing your taxable income by 7.65%.
Here is an example:
- Your self-employed business revenue earnings for 2014 is $50,000.
- First, multiply these earnings by 0.9235. You only need to pay taxes on 92.35% of your self-employed revenue. This results in $46,175, which is your net earnings.
- You would then multiply $46,174 by 15.3% (46,714 multiplied by 0.153), which comes out to $7,064.62 for the Social Security and Medicare taxes you owe or your self-employment tax.
- You would list this entire self-employment tax amount on the 1040 Form under “Other Taxes.”
- Then, you would divide your self-employment tax in half (7,064.62 divided by 2), which comes out to $3,532.31, and on your 1040 Form report this amount as an adjustment to income.
By recording half of your self-employment tax as an adjustment to your gross income, you will be required to pay less income tax overall.
There is an Additional Medicare Tax of 0.9% that only applies if your income exceeds $200,000 for a person who files as single, and more than $250,000 if married and filing jointly. More details on this additional tax can be found here.
Who Pays Self-Employment Tax?
Anyone who doesn’t receive a W-2 from an employer more than likely is responsible for paying self-employment tax. This includes independent contractors, freelancers and consultants. It also includes any sole proprietors or entrepreneurs who run their own business, but do not remove taxes from their earnings throughout the year. If you have a side job that doesn’t provide you with a W-2, you may also be responsible for paying the self-employment tax on wages earned from that job.
Here are a few other questions to ask to determine if you are self-employed and subject to paying the self-employment tax:
- Did you earn more than $400 last year (or more than $108.28 if you are a church employee)?
- Are you the sole proprietor of a business?
- Are you an independent contractor (or is some or all of your income reported on Form 1099-MISC)?
- Are you a member of a business partnership?
- Are you in business for yourself (full- or part-time)?
If you answer yes to any of these questions, you most likely have some amount of self-employment tax to pay.
The good news for all self-employed individuals, however, is that all of these calculations are built into the forms you file as part of your federal tax return. You can figure out your self-employment tax by using Schedule SE (Form 1040). You can also use accounting software to calculate taxes and manage deductions for you, which will expedite the tax-filing process and minimize mistakes that can lead to an audit.
For a more in-depth article on the entire tax-filing process, see our complete guide to taxes for the self-employed.