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What is Self-Employment Tax?

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By Garrett Spence   |    March 6, 2017   |    11:15 AM


Self-employed individuals are required to meet their Social Security and Medicare tax obligations by paying a special tax. In many instances, this tax amounts to an additional 15.3 percent of their earnings.

To make sure you are meeting your tax obligations, learn the ins and outs of the self-employment tax.

The Basics

The self-employment tax was created to hold the self-employed accountable for their Medicare and Social Security dues. With traditional jobs, workers receive a tax rate of 1.45 percent for Medicare and a 6.2 percent rate for Social Security. Additionally, the employer must also pay the same sum, which amounts to 7.65 percent of the worker's wages.

Because self-employed people are both employer and employee, the government holds them responsible for paying the complete sum of Medicare and Social Security taxes. This adds up to 15.3 percent, which accounts for the self-employment tax.

What Are the Limits?

While all self-employed income is subject to Medicare taxes, there is a $118,500 cutoff for the Social Security portion. This means if you earned over $118,500, the remaining portion will not be subject to Social Security tax. Further, if you draw income from another job, that money will be included in the $118,500 cutoff. For instance, if you earned $90,000 from a full-time job and another $60,000 from a side business, only the first $28,500 of your self-employed earnings will be subject to Social Security taxes. That said, the Medicare portion will be applicable to the entire sum.

Who Is Obliged to Pay?

If you run your own business, work as a freelancer or earn income as an independent contractor, you are subject to self-employment tax. What's more, the IRS regards any earnings that do not have taxes withheld as self-employment income. If it didn't come from investments or other passive sources, it will qualify for the self-employment tax. This applies whether you are actually self-employed or merely paid for a small project as an independent contractor. According to the IRS, if your net (not gross) self-employment income exceeds $400, you must pay self-employment tax. You can use your schedule C or C-EZ form to assess your tax liability.

Easing the Burden

While almost all of your net self-employment income will qualify as taxable, there are some ways to lessen the impact. First, before you apply the 15.3 percent multiplier, you are allowed to deduct the "employer's" segment of your self-employment taxes from your net earnings. This can result in a lower taxable net income. Second, because self-employment tax is based on your net earnings, it will be much lower after you add your deductions.

You can also use one-half the amount of self-employment tax you pay as a deduction from your taxable income on your 1040. This won't reduce the self-employment tax, but it could translate into a nice deduction, depending on your tax bracket.

Calculating Self-employment Tax

While it may seem confusing, self-employment tax is not that difficult to calculate. For example, let's say you run a small business that earned a net profit of $80,000. First, you will determine your taxable self-employment income by multiplying the net profit by 0.9235 for a result of $73,880. After applying the 15.3% tax rate to this figure, you get $11,303.64, which represents your self-employment tax. Bear in mind that half of this total is deductible from your taxable income on your 1040. Also, the $80,000 in this example represents your net (not gross) earnings after you've entered all relevant deductions.

Quarterly Payments

If you expect to owe self-employment tax, you should make quarterly estimated tax payments to the Internal Revenue Service. Each payment should amount to 25 percent of your total estimated tax liability for the year. It doesn't have to be perfectly accurate, and many people choose not to do it. Just bear in mind, if you fail to make these payments, you could be subject to penalties. If you anticipate owing less than $1,000 in taxes, you are not required to send quarterly payments. The same is true if your income tax withholdings are anticipated to cover at least 90 percent of your total tax liability.

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