Self-Employment Tax: How to Understand and Calculate It
From time to time, everyone dreams of being their own boss. There is an unmistakable allure to the prospect of holding your destiny in your own hands, not having to answer to any superior but yourself. However, whether you are a seasoned self-employed pro or you are just dipping your toe into the water, there is a superior you must answer to — the IRS.
Regular taxes can be overwhelming enough, but when you throw self-employment taxes into the mix, TAXiety can reach a whole new level. But don’t worry — take a deep breath and read on. Here’s everything you need to know about calculating and paying self-employment taxes.
What is Self-Employment Tax?
At its core, self-employment tax is similar to regular income tax. If you’ve ever been a W-2 employee, you’re probably acutely aware that part of every paycheck goes to state and federal withholdings. And if you’ve ever looked a little closer at where this money goes, you would know that the amount withheld covers your FICA taxes. FICA, an acronym for the Federal Insurance Contributions Act, refers to taxes that fund federal insurance programs such as Social Security or Medicare.
However, if you are self-employed, you will quickly notice that taxes are not automatically withheld from your paycheck; the responsibility falls on the self-employed taxpayer to pay these taxes. In a nutshell, self-employment taxes allow self-employed taxpayers to contribute to FICA and pay other required taxes.
And it gets slightly more complicated. W-2 taxpayers and self-employed taxpayers do not pay the same rate to FICA. This is because a taxpayer’s FICA burden is split 50/50 between employee and employer; for standard W-2 employees, their employers must contribute half of their total FICA tax burden. However, self-employed taxpayers must cover both halves of their FICA burden since they are their own employer.
What is the self-employment tax rate?
According to the IRS, the self-employment tax rate currently stands at 15.3% — a rate that has not changed since 1989. This figure can be broken down further into two parts:
- Social Security, which stands at 12.4%
- Medicare, which stands at 2.9%.
Who needs to pay self-employment taxes?
The IRS considers you ‘self-employed’ if you earned $400 or more in self-employed income and fall into any of these categories:
With the rise in gig work, side hustles, and remote freelancing, independent contract work is more prevalent than ever. Aside from the traditional trade contractors such as electricians and carpenters, the realm of contract work now includes artists, writers, designers, rideshare or delivery drivers, personal shoppers, and more.
According to the SBA, the majority of small businesses fall under the sole proprietorships category. Considered by the IRS to be pass-through entities, sole proprietors are personally responsible for all taxes due — the business entity itself is not responsible. Typical sole proprietorship businesses may include music teaching studios, established freelance creatives, one-person food trucks, and other single-employee ventures.
That’s not all — single member LLCs are treated the same as sole proprieterships and must pay self-employment taxes as well.
Employees of the Church
While churches themselves are not subject to taxation, church employees still must pay tax on their income. Specifically, if a church employee’s income exceeds a paltry $108.28 per annum, they must pay self-employment tax.
Do self-employment taxes vary by state?
Unlike income tax, self-employment tax falls under federal jurisdiction; Social Security and Medicare are federal programs, after all. The self-employment tax rate remains the same regardless of which state you call home.
How to Calculate Self-Employment Taxes
Because they are not automatically withheld from your pay, it’s essential to take self-employment taxes into account when budgeting for the year.
Here’s how to calculate your self-employment taxes.
- Start with your total earnings made during the year you’re filing self-employment taxes. This can be found on Form(s) 1099 from each client.
- Multiply your total earnings by 92.35%. Why 92.35%? It seems arbitrary, right? Well, 7.65% of your income can be deducted to alleviate the total cost of paying both employee and employer-side FICA tax. This is the percentage of your income that’s subject to self-employment taxes, 92.35%. The resulting figure is your taxable income.
- Finally, multiply your taxable income by the self-employment tax rate: 15.3%
After all this, you will be left with your total self-employment tax liability for the year. If it comes out higher than you expected or wanted, don’t fret — there is a plethora of deductions you can potentially use to help lower your liability.
Common Self-Employment Tax Deductions
Good news: if you want to lower your self-employment tax bill, there are plenty of self-employment tax deductions you can claim on your tax return. Some of the most common self-employment tax deduction opportunities include:
- Home Office — Whether you work out of a full-fledged office or a small nook, you can deduct home office expenses to shave dollars off your self-employment tax liability.
- Internet and Cell Phone — Many contract jobs require steady internet and cell phone availability. Leverage internet and cell phone spending into deductions come tax time!
- Health Insurance Premiums — While not considered an operating expense for contractors or sole proprietors, leveraging your yearly spending on health insurance premiums into deductions is entirely possible.
- Software and Tech — If your line of work requires specific software or tech, the licensing fees can be astronomical. Luckily, you can use these fees to lower your liability.
- Advertising Expenses — When working as a contractor or sole proprietor, getting your name out there is half the battle. And in today’s oversaturated media landscape, getting seen is getting expensive. It’s a good thing that advertising spending opens up several possibilities for tax deductions!
Having TAXiety? We Have the Answers.
Paying regular taxes is hard enough. If you find that handling your self-employment taxes gives you TAXiety, don’t hesitate — schedule an appointment with your local Liberty Tax Practitioner. Let the tax pros at Liberty Tax be your tax resource.