Understanding Self-Employment Tax

If you work for yourself, you have to think about many things. One of the most important is the Self-Employment Tax. Many people ask, “What is Self-Employment Tax?” It is the tax that self-employed people must pay to cover Social Security and Medicare.

Unlike regular jobs, where your employer handles part of the tax, self-employed people pay both parts. Knowing how this tax works can help you plan better and avoid surprises during tax season.

What is Self-Employment Tax?

Self-employment tax refers to the tax that people must pay when they earn income by working for themselves. This tax covers contributions to both the Social Security and Medicare programs. These taxes are usually taken out of a paycheck when someone works for an employer. However, if you’re self-employed, you are responsible for making the payments yourself. This tax is very important for freelancers, gig workers, and small business owners.

Self-employment tax comprises important parts:

• 12.4% for Social Security
• 2.9% for Medicare

The total self-employment tax rate is 15.3%, which leads to funding of Social Security and Medicare. Since self-employed persons do not have an employer to share the burden of this tax, they need to cover the entire amount on their own.

Who Needs to Pay Self-Employment Tax?

If you make money through your own business or by offering freelance services, you might be responsible for paying self-employment tax. Some common categories of people are are generally needed to pay the tax are

• Freelancers (writers, designers, programmers, etc.)
• Gig workers (Uber drivers, delivery workers, etc.)
• Small business owners
• Independent contractors
• Partners in a business

The IRS says you must pay self-employment tax if your net income is $400 or more in a year. If you earn $108.28 or more from work with a church or a church group, you may also need to pay this tax. Even if you have a regular job, if you earn from the rise of one side, you will have to pay self-employment tax on that income.

How is the Self-Employment Tax Calculated?

A step-by-step guide for determining the self-employment tax

Figure out your net income

• Add up all your self-employment income.
• Subtract your business expenses.

Multiply your net income by 92.35%

• This is because only 92.35% of your net earnings are taxed for Social Security and Medicare.

Apply the 15.3% rate

• 12.4% goes to Social Security (only on income up to a limit).
• 2.9% goes to Medicare (no income limit).

Example:

If you earn $50,000 net income from freelancing:

$50,000 x 92.35% = $46,175

$46,175 x 15.3% = $7,060 self-employment tax

Note: For income over $160,200 (2023), Social Security tax no longer applies. But the 2.9% Medicare tax still does. And if you earn more, then you might have to pay additional 0.9% medicare tax.

What is the 92.35% Rule?

You don’t pay Self-Employment Tax on your full income. The IRS gives you a small deduction.

• You multiply your net earnings by 92.35% before applying the 15.3% tax rate.
• This rule lets you act like an “employer” who gets to deduct payroll taxes.
  
  

Example:

• You earn $60,000 from your freelance work.
• $60,000 × 92.35% = $55,410
• $55,410 × 15.3% = $8,478.63
• So, you owe $8,478.63 in Self-Employment Tax.

Filing Requirements and Deadlines for Self-Employment Tax

To file your self-employment tax, you must fill out specific IRS forms:

• Schedule SE: This is used to calculate the self-employment tax.
• Form 1040: Form 1040 is the main tax return form. You report the self-employment tax here.

Quarterly Estimated Payments

As taxes are not taken out of your income, the IRS expects you to pay them four times a year.

• April 15
• June 15
• September 15
• January 15 (of next year)

To calculate estimated payments, use:

• Form 1040-ES

It is better to pay quarterly. Using this method, you can avoid fines and interest from the IRS.

Common Mistakes to Avoid with Self-Employment Tax

Many people make mistakes when dealing with self-employment Tax. Here are some to watch out for:

• Not setting aside money for taxes: Always save around 25–30% of your income.
• Missing quarterly payment deadlines: Late payments can lead to penalties.
• Underestimating your income: Estimate correctly to avoid a big tax bill later.
• Not keeping records: You should keep all receipts and invoices with you to support your deductions.
• Forgetting to report all income: The IRS receives copies of 1099 forms. Make sure you include them.

Tips to Reduce Your Self-Employment Tax Liability

Self-employed workers can use smart strategies to reduce the amount they owe. Here are some ways:

1. Claim all deductions

You can deduct many business expenses:

• Internet and phone bills
• Office supplies
• Software tools
• Business travel
• Meals (50%) during business meetings
• Home office expenses may be deductible if the space is used exclusively and regularly for work purposes.

This minimizes your net income, which also decreases your self-employment Tax.

2. Consider forming an S-Corporation

If your business is growing, you might save money by forming an S-Corp.

• You pay yourself a reasonable salary and take the rest as a distribution.
• Distributions are not subject to self-employment tax.

Always consult a tax advisor before switching.

3. Retirement contributions

Contribute to a retirement plan like:

• SEP IRA
• Solo 401(k)

This reduces your taxable income and reduces your tax bill.

4. Health insurance deduction

• If you pay your own health insurance, you may be able to deduct the premium from your income.

5. Tax planning

• Plan ahead for each quarter. Estimate your earnings and expenses. Monitor all the tasks using accounting software or hire a tax professional.

What If You Have a Job and Side Business?

If you work a regular job and do freelance work on the side, here’s how it affects your taxes:

• Your employer pays part of your Social Security and Medicare:
  Your employer pays half of your Social Security and Medicare taxes. This lowers your tax on regular income.

• You still pay Self-Employment Tax on your freelance income:
  You will pay Self-Employment Tax on the money you earn from freelance work. This covers Social Security and Medicare.
• The Social Security tax only applies up to a yearly income limit:
  The Social Security tax only applies to income up to a certain amount each year. Once you reach that limit, you don’t pay more.
• The Medicare tax has no limit and may include the extra 0.9%:
  The Medicare levy applies to all income, with no cap. If you earn over a certain amount, you may also pay an extra 0.9% Medicare tax.

Understanding what is Self-Employment Tax is important if you work for yourself. This tax covers Social Security and Medicare. If you are working as a freelancer, gig worker, or operating a small business, then you must pay this tax. You should learn how to determine it, avoid common mistakes, and use innovative software and smart tips to reduce your bill. However, with little but careful planning, you can stay ahead and avoid trouble with the IRS.

Meru Accounting helps self-employed pros with tax filing, smart planning, and compliance, so they can focus on their work without stress about deadlines or fines. Our tax professionals ensure your taxes are filed accurately and on time.

FAQs

1. What is Self-Employment Tax?
   It is a tax that covers Social Security and Medicare for self-employed people.

2. Who needs to pay it?Anyone who earns $400 or more in net self-employment income must pay.

3. How much is the tax?The rate is 15.3% on 92.35% of your net income.

4. Do I have to pay it quarterly?
   Yes, if you expect to owe over $1,000 in a year.

5. Can I lower this tax?Yes, by claiming business expenses and contributing to retirement plans.

6. Do I still pay if I also have a regular job?Yes, on your freelance income, up to the Social Security limit.

7. What happens if I don’t pay?
   You may face penalties, interest, or legal action from the IRS.