What is the self-employment tax?

Are you a freelancer or independent contractor? Get ready for tax season with our guide to self-employment taxes.

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While you may have thought you’d avoid getting a chunk of your income taken out as your own boss, that is, sadly, not how it works. As a self-employed individual, you must pay a self-employment tax.

The “self” affixed to the phrase doesn’t mean the money is funneled back to you. So, when tax season rolls around, make sure that you know precisely what self-employment tax is and how it will affect you.

Self-employment tax background

In 1935, the passage of the Federal Insurance Contribution Act (FICA) led to the FICA tax, which was enacted to ensure funding for Social Security and Medicare. The FICA tax is 15.3%. However, the employer and employee split the tab on it, each paying 7.65%.

And, to prevent everyone from becoming self-employed for the favorable tax rate the Self-Employed Contribution Act arrived in 1954, so everyone would pitch in their fair share for Medicare and Social Security.

Just like it’d be wrong to show up to a potluck empty-handed but feast like you’re at a Vegas buffet, it would be unfair to not contribute to retirement funds.

What is self-employment tax?

The self-employed tax rate is currently 15.3% of your net self-employed income—your profit. Here’s the breakdown of how much estimated tax you’ll owe:

Social Security – 12.4%. While the rate changes each year, for 2020, a threshold of $137,700 of your earnings is subject to the Social Security tax.

Medicare – 2.9%. Under the 2013 Affordable Care Act (ACA), an additional 0.9% Medicare tax may be applied if your self-employment net earnings exceed the threshold of $200,000 (single filer), $250,000 (joint-filing for married couples), $125,000 (married couples filing separately).

It can get a bit complex. Sometimes, a string of numbers can send you back into a stupor you haven’t experienced since the alphabet was introduced into math class. So, here’s an example to demonstrate: Alicia makes $147,700 in net earnings from self-employment in 2020. She files as a “single” and will have to apply a 12,4% tax on her first $137,700. The remaining $10,000 is not subject to the Social Security tax.

Who has to pay self-employment tax?

If you didn’t make any profits this year, then you spared yourself the headache of figuring out taxes for the nth year of your life. But, that also means you won’t receive any credits for Social Security or Medicare for this year.

So, who does have to pay self-employment tax? The answer is anyone who:

  • Made or exceeded $400 in taxable income while self-employed
  • Made or exceeded $108.28 in income from church employment

You are subject to these tax rules, regardless of your age or whether you are already receiving Social Security or are serviced by Medicare. Ben Franklin knew what he was talking about.

Which businesses pay self-employment taxes?

All small businesses’ income is subject to the tax. As a pass-through institution, net profit is provided directly to owners, leaving them responsible for reporting them on personal tax returns.

Examples of pass-through businesses include:

  • Limited Liability Corporations (LLCs)
  • S-Corporations
  • Being a sole proprietor (e.g., freelancer and independent contractor)
  • Traditional partnerships

Tax deductions

Now comes the part everyone hones in on to save money. And, with a 15.3% tax, we can’t blame you. The seemingly high rate, however, needs only to apply to your net earnings, meaning you can subtract tax deductions (like business expenses) from your gross earnings.

With some research, you can find additional self-employment tax deductions that might apply to you, such as:

  • Qualifying work-related education
  • Vehicle (for business use) expenses
  • House-related costs (if you operate a business partly out of your residence or work from home)

These deductions don’t apply to just anyone, but they’re worth looking into. After all, a bit of research or consultation can save you quite the pretty penny in estimated tax payments. And, being self-employed doesn’t mean you don’t like to save; everybody loves a good bargain.

What do I do if I have self-employment income and employment income?

The Internal Revenue Service (IRS) isn’t your younger sibling; you can’t hand them the smaller half of the candy bar and hope they don’t notice. If you have both, you have to submit both for consideration using the long form of Schedule SE. In doing so,

  • Social Security tax is capped at the yearly maximum.
  • Additional Medicare Tax is applied at the threshold, if applicable.
  • The self-employment tax can be calculated accurately, with employment first and then self-employment income to the threshold for Social Security.

Taking your business’ future in your hands​

While the self-employment tax rate can be jarring to the newly self-employed, it’s imperative that you remember that you’ll receive equal benefits in the future and that it’s possible to save via tax deductions. If the process gets too crazy, don’t be afraid to seek professional assistance.

After all, as a freelancer, contractor, or small business, it’s essential to manage your business responsibly. With that said, don’t forget to protect your financial assets, day-to-day operations, and reputation with general liability insurance and professional liability insurance. Just like paying your business taxes is a necessity, staying insured is another way to make sure that nothing comes between you and doing what you love.

Our editorial content is intended for informational purposes only and is not written by a licensed insurance agent. Terms and conditions for rate and coverage may vary by class of business and state.

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