All About Self-Employment Tax

As an employee, you may have noticed that your paycheck never matches your full salary. This is because your employer has to withhold certain payroll taxes. You might think that you don’t have to worry about those payroll taxes if you work for yourself. But that’s not the case – you still have to pay a 15.3% self-employment tax. Below, we’ll explore this tax and why you have to pay it. If you need help with this or any other tax issue, consider working with a financial advisor.

What Is the Self-Employment Tax?

In 1935, the federal government passed the Federal Insurance Contribution Act (FICA), which established taxes to help fund Social Security and Medicare. The FICA tax is 15.3% of gross earnings. The tax is paid by employers and employees, who split the burden by each paying half. Employers pay 7.65% and their employees pay 7.65%.

To ensure that self-employed individuals still contribute toward Social Security and Medicare, the federal government passed the Self-Employed Contributions Act (SECA) in 1954. SECA established that self-employed individuals would be responsible for paying the whole 15.3% FICA. This tax paid by self-employed individuals is known as the SECA, or more simply, the self-employment tax.

Self-Employment Tax Calculation

The total self-employment tax is 15.3% and consists of two parts. The first part is a 12.4% levy to fund Social Security. The law sets a maximum amount of net earnings that are subject to the Social Security tax. Anything over that amount is not subject to the tax. This cap may change annually and has steadily increased over time, reaching $168,600 in 2024, up from $160,200 in 2023.

Let’s say you have $175,000 in net income from self-employment in 2024. You will pay a 12.4% tax on the first $168,200. However, you do not have to pay any Social Security tax on the remaining $6,800.

The second portion of your self-employment tax funds Medicare. The rate for Medicare lands at 2.9%. Unlike with Social Security tax, the Medicare tax applies to all of your net earnings regardless of how much you earn. If you have $175,000 in net earnings, as in the previous example, you must pay the 2.9% Medicare tax on the entire $175,000.

Since 2013, there has been an additional 0.9% Medicare surtax on income over a certain threshold, a change instituted under the Affordable Care Act (ACA). The threshold is currently $200,000 for single individuals and heads of households, $250,000 for married couples filing jointly and $125,000 for married couples filing separately.

So if you file as a single and earned $250,000 for tax year 2024, the first $200,000 in income is subject to the 2.9% Medicare tax. The remaining $50,000 is subject to the 0.9% surtax.

Self-Employment Tax: Who Needs to Pay

As a rule, you need to pay self-employment tax if your net earnings from self-employment are at least $400 over the tax year. This includes individuals who have their own businesses, as well as independent contractors and freelancers. You do not need to pay self-employment tax on income that you earn from an employer if the employer withheld payroll taxes.

Other situations may require you to pay self-employment tax. For one, you still need to pay even if you are a U.S. citizen employed by a foreign government. You must also pay self-employment taxes if you earn more than $108.28 as an employee of a church. If you earn untaxed income in these situations and are unsure whether it’s subject to self-employment tax, it’s best to visit the IRS website or speak with a tax professional.

To review, if you work a full-time job that has payroll taxes deducted but then you earn $1,000 through freelance work, you have to pay self-employment tax on the net earnings from that $1,000 (unless the net is under $400).

Additionally, self-employment tax applies no matter how old you are. If you meet the above requirements and are already receiving Medicare and Social Security benefits, you will still have to pay the tax.

What Are Net Earnings?

The 15.3% tax seems high, but the good news is that you only pay self-employment tax on net earnings. This means that you can first subtract any deductions, such as business expenses, from your gross earnings.

One available deduction is half of the Social Security and Medicare taxes. That’s right, the IRS considers the employer portion of the self-employment tax (7.65%) as a deductible expense. Only 92.35% of your net earnings (gross earnings minus any deductions) are subject to self-employment tax. There are several other tax deductions that self-employed individuals can claim to reduce their taxable earnings, like if you use your home for business.

Let’s say you earn $1,500 from a freelance job and claim $500 in deductions. You would then multiply the net $1,000 ($1,500 minus $500) by 92.35% to determine your taxable earnings. In this example, only $923.50 ($1,000 multiplied by 92.35%) is subject to self-employment tax.

Self-Employment Tax Filing

When filing your annual return, use Schedule C of Form 1040 to calculate your net self-employment income. If your business expenses come out to $5,000 or less, you may be able to file Schedule C-EZ instead of Schedule C. 

The Schedule C or Schedule C-EZ will give you your calculated income or loss. This number will then be used on Schedule SE (Form 1040), Self-Employment Tax to calculate how much self-employment tax you should have paid throughout the year.

If you file a joint return with another self-employed person, you must calculate your self-employment taxes separately. The SECA does not allow joint filers to merge their incomes. Again, you will want to check IRS instructions or seek professional financial help to ensure you file your taxes correctly.

In addition to filing an annual tax return, you generally have to make quarterly estimated tax payments if you are self-employed. Estimated tax is used for the self-employed since there is no employer to withhold the taxes. To file these quarterly payments, you use Form 1040-ES, Estimated Tax for Individuals. You will need your annual tax return from the previous year to correctly fill out this form. Filling out the form’s worksheet will determine whether you need to file quarterly estimated tax.

To make your quarterly payments, you can use the Electronic Federal Tax Payment System or you may mail in blank vouchers found in Form 1040-ES. The first installment of estimated taxes for tax year 2024 is due April 18. The fourth and final installment is due January 16, 2024.

Estimated Self-Employed Tax Due Dates

Bottom Line

Self-employment tax ensures that self-employed individuals make the same contribution and receive the same value of benefits as salaried workers. The 15.3% may shock those who are newly self-employed. But when all is said and done, tax deductions can save you from paying the entire tax.

Don’t forget that without an employer, you will have to do a lot of the tax math to do yourself. If you find yourself overwhelmed or confused by the forms and regulations, you may benefit from professional tax help.

Tax Tips

• A financial advisor can also help you optimize your tax strategy for your financial goals and needs. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
• SmartAsset’s income tax calculator can be a help if you have a traditional job and want to know what your bill to Uncle Sam will be.
• A financial advisor who specializes in tax planning can help lower your 1099 income taxes by harvesting your losses. This means that you will be able to use your investment losses to reduce taxes on 1099 income.

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