The Basics of Self-Employment Taxes
Self-employment offers many freedoms and opportunities, but it also comes with financial responsibilities, including self-employment taxes.
Understanding the fundamentals of self-employment taxes is crucial for individuals who work for themselves.
In this article, we’ll explore what self-employment taxes are and how they work.
What Are Self-Employment Taxes?
Self-employment taxes are a combination of Social Security and Medicare taxes that self-employed individuals are required to pay.
While employees and employers share the burden of these taxes in traditional employment,
self-employed individuals are responsible for both the employee and employer portions.
How to Calculate Self-Employment Taxes
Self-employment taxes are calculated based on your net earnings from self-employment. Here’s how you can calculate them:
1. Determine Your Net Earnings
Net earnings are your total self-employment income minus deductible business expenses.
2. Calculate Social Security Tax
Multiply your net earnings by the Social Security tax rate, which is 12.4% (as of 2021), and is split into 6.2% for the employee and 6.2% for the employer.
3. Calculate Medicare Tax
Multiply your net earnings by the Medicare tax rate, which is 2.9% (as of 2021), and is split into 1.45% for the employee and 1.45% for the employer.
4. Additional Medicare Tax (if applicable)
If your income exceeds a certain threshold ($200,000 for single filers and $250,000 for married filing jointly), you may be subject to an additional 0.9% Medicare tax.
Reporting Self-Employment Taxes
Self-employed individuals report and pay their self-employment taxes using Schedule SE, which is filed along with their annual income tax return (Form 1040).
It’s essential to keep accurate records of your income and expenses to determine your net earnings accurately.
Estimated Quarterly Payments
Unlike traditional employees who have taxes withheld from their paychecks, self-employed individuals are responsible for making estimated quarterly tax payments to cover their self-employment tax liability.
Failing to make these payments can result in penalties and interest.
FAQs
Can I deduct business expenses to lower my self-employment taxes?
Yes, you can deduct legitimate business expenses from your self-employment income, which can reduce your taxable income and, consequently, your self-employment tax liability.
What if I have both self-employment income and a traditional job?
If you have income from both self-employment and traditional employment, you may need to adjust your withholding or make estimated quarterly payments to ensure you’re covering your self-employment tax liability.
Are there any tax credits or deductions available to self-employed individuals?
Self-employed individuals may be eligible for tax deductions, such as the home office deduction and the self-employed health insurance deduction. Additionally, they can contribute to retirement accounts like a Simplified Employee Pension (SEP) IRA or a solo 401(k).
How do I know if I need to pay the additional Medicare tax?
The additional Medicare tax is applicable if your income exceeds specific thresholds ($200,000 for single filers and $250,000 for married filing jointly). If you meet these income criteria, your employer should withhold the additional tax from your paycheck. If you’re self-employed, you’ll need to calculate and pay it when you file your return.
Also Read: Who Has to Pay Federal Income Tax?
