Have you started your own business, freelance, or work as an independent contractor? Then get ready to pay the self-employment tax, which is a tax you never had to pay as an employee. The self-employment tax (officially known as the SECA tax for Self-Employment Contributions Act tax) is the self-employed person's version of the tax paid by employers and employees for Social Security and Medicare, and it's due on your net earnings from self-employment.
Key Takeaways
- If you're self-employed, you're responsible for paying both the employer and employee portions of your Social Security and Medicare tax—a total of 15.3 percent on 92.35 percent of your net earnings from self-employment.
- Use Schedule SE to calculate your self-employment tax. Report the tax amount from Schedule SE in the "Other Taxes" section of Form 1040.
- When calculating your self-employment income, you are allowed to subtract half of your self-employment tax from your income before applying the tax rate.
- If you owe $1,000 or more in federal taxes for the tax year, you may need to make estimated quarterly tax payments using Form 1040-ES.
Do I need to pay the self-employment tax?
So, you’ve started a business or decided to freelance, and freed yourself from the daily grind of that old job. But there’s no freedom from paying taxes. In fact, you’ll owe tax that you never had to pay as an employee if you made $400 or more in self-employment net income. The self-employment tax (officially known as the SECA tax for Self-Employment Contributions Act tax) is the self-employed person's version of the FICA (Federal Insurance Contributions Act) tax paid by employers and employees for Social Security and Medicare, and it's due on 92.35% of your net earnings from self-employment.
What is the self-employment tax?
Many newly self-employed people—sole proprietors, independent contractors and the like—are surprised at their tax bills at the end of the year because they notice they're suddenly paying a lot more in tax as a self-employed person than as an employee. That's because they're carrying the full burden of paying for their Social Security and Medicare.
When you're an employee, youshare that cost with your employer, with each of youpaying a share of the FICA tax. Your share is automatically taken out of your paycheck so it doesn't typically show up on your tax return. When you're self-employed, though, you're stuck with the full amount yourself.
The tax is divided into two parts:
- 12.4% for Social Security. For 2023, this part of the tax applies to the first $160,200 of earnings. If you earn more than that (from self-employment or, if you also have a job, from the combination of your job and your self-employment), then the 12.4 percent part of the tax that pays for Social Security stops for the year.
- 2.9% for Medicare. The Medicare portion of the self-employment tax doesn’t stop. No matter how much you earn, you'll pay the 2.9 percent Medicare tax. For more information on this tax, see IRS Tax Topic 554: The Self-Employment Tax.
How do I report the self-employment tax?
Of course, a new tax means new paperwork too. When you start a small business and you do not incorporate or form a partnership, you typically report the results of your operations on Schedule C and file it with your Form 1040.
You calculate your self-employment tax on Schedule SE and report that amount in the "Other Taxes" section of Form 1040. In this way, the IRS differentiates the SE tax from the income tax.
TurboTax Tip:
You're allowed to deduct 50% of what you pay in self-employment tax as an income tax deduction on Form 1040. This deduction is available whether or not you itemize deductions.
Good news
When figuring self-employment tax you owe, you get to reduce self-employment income by half of the self-employment tax before applying the tax rate. Say, for example, that your net self-employment income is $50,000. That's the amount you report as taxable for income tax purposes on Form 1040.
But when figuring your self-employment tax on Schedule SE, Computation of Social Security Self-Employment Tax, the taxable amount is $46,175. Not paying the 15.3 percent tax on the $3,825 difference in this example saves you $585.
More good news
You can claim 50% of what you pay in self-employment tax as an income tax deduction. For example, a $1,000 self-employment tax payment reduces taxable income by $500. In the 25 percent tax bracket, that saves you $125 in income taxes. This deduction is an adjustment to income claimed on Form 1040, and is available whether or not you itemize deductions.
An example
- You run a catering business as a sole proprietor.
- In 2023 your net profit as reported on Schedule C is $35,000.
- Your net earnings subject to self-employment tax as calculated on Schedule SE would be $32,323 ($35,000 x 0.9235).
- Your self-employment tax would be $4,945 (32,323 x 0.153) and you would report that amount on Form 1040 in the "Other Taxes" section.
Then you would report one-half of your self-employment tax, $2,473, ($4,945 X .50) on Form 1040 as an adjustment to income, which reduces your Adjusted Gross Income and the amount of income tax you owe.
Should I file estimated taxes?
If you have worked as an employee, you know that what you get in your paycheck is usually less than what you really made. Why? Because your employer withheld money for Social Security, Medicare and income tax and sent that money to the government.
When you are self-employed, the entire burden for paying employment taxes and prepaying estimated income tax liability is left to you. The government wants you to make payments of your estimated taxes throughout the year in quarterly installments. If you don't, you may be subject to underpayment penalties.
- If you're not sure whether you meet the definition of being self-employed, see IRS Tax Topic 554: The Self-Employment Tax.
- For more information on estimated taxes, see this IRS article on Estimated Taxes.
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