Chances are if you are reading this, then you are self-employed or interested in becoming a small business owner. Congrats! However, if this is you, it’s important to consider self-employment taxes.
Self-employed means you fit any of the following:
- You carry on a trade or business as a sole proprietor (single-member LLC included) or receive income as an independent contractor ( you receive 1099-NEC).
- You are a member of a partnership (multi-member LLC) that carries on a trade or business. Keep in mind, partnerships must file a separate partnership return in addition to each partner’s individual income tax return.
- You are otherwise in business for yourself, including a part-time business such as graphic designer, publish a blog/vlog, gate guard, artist, software engineer, etc.
What is it?
Self-employment tax is made up of Social Security (12.4%) and Medicare tax (2.9%). It totals 15.3%. You pay self-employment taxes on the NET profit from your business as either a sole proprietor or an active partner in a partnership.
Self-employment taxes are bundled into your total tax owed at the end of the year on a tax return which is why many people don’t even know they are paying them. This means your total tax liability includes self-employment taxes in addition to your federal income tax.
Let’s clarify that if you’ve ever had a W-2 job, you’ve paid into both Social Security and Medicare, possibly without even realizing it. As an employee, you pay half of the Social Security and Medicare taxes (7.65% of your wages) while your employer pays the other half. These taxes come directly out of your paycheck without you evening having to notice or think about it.
However, as a self-employed individual, you are both employEE and employER. Therefore, you are responsible for ALL the Social Security and Medicare taxes (15.3% of your “net profit”).
Who owes self-employment tax?
Anyone who files a Schedule C as part of their personal tax return (1040). This includes single-member LLCs, the most misunderstood entity structure. You need to have a net profit to owe self-employment taxes.
Anyone who is an active partner in a partnership. If you’re a limited partner, then you most likely won’t owe self-employment taxes.
Keep in mind you might owe self-employment tax even if you don’t have enough income after deductions and credits to owe income tax!
Currently, the IRS has a cap on income for Social Security. For 2022, this is $147,000. This means you only need to pay the Social Security portion of self-employment tax on any profit up to this income limit.
How do you pay self-employment taxes?
The easiest and best way to stay on top of self-employment taxes is to make quarterly estimated payments online via IRS direct pay. These payments will cover your self-employment tax (SE tax) and any personal income taxes you might owe for the year.
Many people call these your quarterly estimate taxes. These are really just you paying taxes on a quarterly basis because the IRS is a pay-as-you-earn tax system. This means that you must pay income tax as you earn or receive any income throughout the year. You do this either through withholdings on your W-2 paycheck, usually done by your employer OR by making quarterly estimated tax payments.
Quarterly tax payments are usually due April 15, June 15, September 15, and January 15 (the following year) unless those dates fall on a weekend or holiday. A trusted tax professional can help create estimates for you based on prior year income and current year earnings. It’s fine to pay different amounts per quarter based on income earned during that time frame.
If your business earns nothing in the first quarter, then you can opt-out of the first quarter payment. Consequently, if your business earns a larger amount in the 4th quarter, then pay more tax on January 15th. You can make the final decision about how much tax to pay each quarter, but make sure the total is enough to satisfy your tax liability or be ready to pay come tax time.
Are self-employment taxes deductible on your tax return?
Yes. Sort of.
Self-employment taxes for sole proprietors and partners are partially deductible on your personal income tax return (Form 1040). Since employers typically pay half of these taxes, the IRS allows you to take half of your self-employment tax as a deduction on your personal income Form 1040. This deduction is usually taken on Schedule 1.
Anything is helpful when it comes to lessening your tax burden, right?
What form is used to calculate self-employment taxes?
Schedule SE is used to calculate the amount of self-employment taxes you will owe.
You’ll need the net profit from your Schedule C or your K-1 from a partnership to use this form.
Both Schedule SE and Schedule C are filed with your personal tax return as part of your 1040. If you are a partner, then you’ll use the K-1 to file with your 1040.
How do you calculate what you’ll owe?
You need to calculate your net profit or net loss from your business.
Net profit (loss) = income – expenses
Business income = $65,000
Business expenses = $15,000
Net Profit = 65000 – 15000 = $50,000
The $50,000 is the amount you would use to calculate any self-employment tax.
Self-employment income tax is 15.3%, so figure out any net profit you have and then you’ll know how much to pay. Simple, right?
Not quite. Since the IRS allows for a deduction of half your self-employment taxes. You’ll need to take this into consideration when making estimated payments.
Here’s the formula:
Net profit from your business X 92.35% (.9235) = business income subject to self-employment tax
If this calculation is less than $147,000, then you’ll use this formula:
your business income subject to self-employment tax X 15.3 % = self-employment tax obligation
If this calculation is over $147,000, then you’ll use this formula:
your business income subject to self-employment tax X 2.9 % + $18,228 = self-employment tax obligation
If you’d prefer, you can use the IRS Schedule SE worksheet to help calculate your self-employment tax obligation.
How do I avoid any penalties?
Generally, most taxpayers avoid underpayment penalties if they either
- owe less than $1,000, or
- pay at least 90% of the current year’s tax, or
- pay 100% of the tax shown on your prior-year return, whichever is smaller.
If you didn’t pay enough tax throughout the year, either through withholding or by making estimated tax payments, you may have to pay a penalty for underpayment of estimated tax.
Simply put, you must pay (whichever is less)
- at least 90% of your current year tax OR
- 100% of the tax from the prior year
How do I save for taxes?
Generally, I advise my clients to have a separate account for tax savings. With each paycheck or contractor payment, I suggest putting aside 20-25% into this separate tax savings account. This could be higher if you are a high-income earner or also have state taxes to pay. It could be slightly less if your income is on the lower side and/or you have lots of deductions and/or credits.
This way when it comes time for your quarterly payment, you have the money already set aside and ready to go.
If you end up having extra in this savings account, score!
We all start somewhere. Hopefully, you now have the answers to your burning questions regarding self-employment taxes. What other burning questions do you have about self-employment taxes?