Self-Employment Tax

Unlike salaried employees, independent contractors and small business owners must pay their Social Security and Medicare Tax. That's why keeping careful records and making quarterly estimated payments throughout the year is important.

People who work for themselves must pay both Social Security and Medicare taxes (hospital insurance) on their net self-employment income. The Social Security tax is 12.4%, and the Medicare tax is 2.9%. No income ceiling applies to the Social Security tax, but there is an annual limit for how much of your net earnings can be subject to the Medicare tax. In addition, since 2013, an additional 0.9% Medicare surtax on income over a certain threshold was instituted to fund Obamacare.

How to Calculate Self-Employment Tax?

Calculating your self-employment tax can be tricky, and it’s important to accurately track all of your business-related expenses to get the maximum allowed deductions. Many of the top tax software programs for small businesses include a self-employment tax calculator that can make the task much easier.

To calculate your self employment tax, start by determining your net earnings from your business (as reported on IRS Schedule C). Then, add the amount of any 1099 income you received from other sources of income listed on your Form 1040. Finally, subtract your business-related expenses to arrive at the total SE tax you owe.

Self Employment Tax Form
Self-Employment Tax 1

Self Employment Tax Form

In most cases, you must figure and pay your self-employment tax quarterly. The IRS’s Form 1040-ES has vouchers that you can use to make your payments electronically or mail in the blanks. The Form 1040-ES also tells you if you need to file quarterly or annually.

The Social Security and Medicare taxes that you pay as a self-employed person are equivalent to the FICA taxes withheld from the paychecks of most wage earners. The only difference is that you calculate and pay your own Social Security and Medicare taxes using Schedule SE.

To determine how much you owe, multiply your net self-employment income by the Social Security and Medicare tax rates. Then, add the result to your adjusted gross income on line 15 of Form 1040. Self-employed individuals can deduct half of their self-employment tax as an above-the-line deduction on line 1 of Form 1040. This is an employer-equivalent deduction, and it mirrors the matching Social Security and Medicare contributions your boss would have made if you worked for him.

How to Minimize Self-employment Tax?

You can take some steps to minimize your self-employment tax bill. The most important thing is to accurately track your income and expenses. This way, you’ll be prepared to maximize your tax deductions come filing season.

Another option is to structure your business as a corporation or S-corporation. These options can reduce your self-employment tax rate by allowing you to deduct more of your business’s expenses from your income. Finally, you can make quarterly estimated tax payments throughout the year to avoid owing any money at tax time. The IRS provides a Schedule SE and vouchers that you can use to calculate your quarterly payments.

If you don’t file your taxes on time, the IRS will impose penalties on top of your tax bill. If you’re not confident in correctly filing, consider partnering with a financial advisor or accountant who can guide you through the process. Getting organized and staying on top of your taxes will also help reduce stress at tax time. The more you know about self-employment taxes and how they work, the less likely you are to be hit with a surprise bill from the IRS.

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