[Updated April 2018.]
Please keep in mind that this article is not tax advice; You should always consult your tax advisor when calculating your taxes.
How many times a month do you find yourself daydreaming about wandering into the land of self-employment?
While self-employment can provide the freedom and flexibility you yearn for, it also adds some tax complexity. A classic example? Something called the self-employment tax.
In this article we’ll share the basics about the self-employment tax: How it works, how to calculate your own, and, (spoiler alert!) how to deduct part of it. Now you should always consult your tax professional for your tax matters, but this is a quick primer for the self-employed who want to self-educate.
What is the self-employment tax?
The self-employment tax (SE tax) has two parts: Social Security and Medicare, which together take about 15.3 percent of your earnings. As a quick reminder, folks who work for themselves need to pay both income tax and self-employment tax.
Social Security and Medicare are like the salt and pepper of any federal tax dinner spread: they’re sprinkled on top of nearly every income earner’s tax contributions.
Whether you work for yourself or are a typical full-time employee who works at a company, you likely have to contribute towards Social Security and Medicare. A big difference, however, is that when you are paid wages as an employee, your employer splits the Social Security and Medicare taxes with you. When you rely on your own income, you’re responsible for the full 15.3 percent.
Now let’s give that salt and pepper an extra shake, as there’s a crucial change to this in 2018.
Social Security Tax
The Social Security tax rate is 12.4 percent of your earnings. Starting this year (2018), you will pay Social Security taxes on earned income up to $128,400. This is a jump from the 2017 rate of $127,200. Note that the $128,400 limit reflects all earned income, not just your self-employed income. That means that anything you earned above that $128,400 is not subject to Social Security Tax.
The Medicare withholding rate is 2.9 percent of earnings. There is no earnings limit for Medicare taxes. However, the Additional Medicare tax of 0.9 percent kicks in for those of you with earned income over a certain threshold based on your filing status ($200,000 for single filers, or $250,000 for mrried filing jointly), which makes for a total of 3.8 percent Medicare tax due on your earned income over the applicable threshold.
We know, that’s a mouthful, so check out the IRS website for more information on the Additional Medicare tax.
Do I have to pay self-employment taxes?
Most likely, yes. In general, under IRS guidance you are considered self-employed if you are:
- A sole proprietor of a business or trade
- An independent contractor
- Part of a partnership that carries on a trade or business
What if you’re paid wages as an employee, but also have a side hustle? Then you may be required to pay SE tax on the earnings of your side gig.
And one more important note: Since SE taxes are not withheld automatically during the year, many self-employed individuals are required to make estimated tax payments before year-end, if they have more than $1,000 of tax due when filing their tax return.
Check out the IRS’s write-up for more on estimated tax payments.
How do I calculate how much I owe for the self-employment tax?
Put your third-grade hat on: it’s time for some multiplication tables. But this time, with bigger (and weirder) numbers.
Step 1: Grab your handy 1040 Form
Working for yourself, you’ll have to get nice and cozy with an individual income tax return, the Form 1040 and Schedule SE, which computes your self-employment tax. You won’t use this form to crunch the actual numbers, but we’ll show you where to record important calculations since you can deduct part of your SE taxes.
Step 2: Figure out the amount of your earnings that is actually taxable for the SE tax
Let’s say your self-employment earnings were $100,000 for 2018. According to the IRS, most, but not all of your total earnings would be subject to the SE tax. To find out what’s taxable, multiply your earnings ($100,000) by .9235. In this case, it comes out to $92,350.
Why is 92.35 percent of your earnings taxable? Because that 7.65 percent deduction takes into account the employer-half of the FICA tax, which the business would be able to deduct if you were paid as an employee. Spoiler alert: That’s why you can deduct that amount as a self-employed individual.
Step 3: Calculate the amount you owe for SE taxes
Next, simply multiply your self-employment taxable income ($92,350 in this case) by 15.3 percent, which equals $14,129.55. Voila: that’s the total amount you owe for the SE tax. If you’ve got your 1040 Form handy, list that entire SE tax amount on the 1040 Form under “Other Taxes.”
Step 4: Report half of your SE tax as an adjustment
There’s one more bonus step: You can report half of your total SE tax as an adjustment to your gross income, which means you pay less income tax overall. The IRS considers this step to be the employer-equivalent portion of your self-employment tax.
So, back to our example: Divide your entire SE tax of $14,129.55 in half, which gives us $7064.78. Report this number on your 1040 Form as an adjustment to your income.
And there you have it: The self-employment tax, in a nutshell. The next time you’re asked to pass the salt and pepper at a party, you’ll know that’s your cue to discuss everyone’s favorite dinner topic: Social Security and Medicare.