Self-Employment Tax

Self-employment tax is the imposed tax that a small business owner must pay to the federal government to fund Medicare and Social Security. Self-employment tax is due when an individual has net earnings of $400 or more in self-employment income over the course of the tax year.

The self-employment tax is to be paid by workers who are considered self-employed. This includes sole proprietors, freelancers, and independent contractors who carry on a trade or business. A member of a partnership that carries on a trade or business may also be considered to be self-employed by the Internal Revenue Service.

In any business, both the company and the employee are taxed to pay for the two major social welfare programs – Medicare and Social Security. When an individual is self-employed, she is both the company and the employee, so she pays both portions of this tax. Social Security tax is assessed at a rate of 6.2% for an employer and 6.2% for the employee. A self-employed worker will be taxed 6.2% + 6.2% = 12.4%, as s/he is considered to be both an employer and an employee. The Social Security tax is only applied to the first $128,400 of self-employment income earned, for a maximum tax of $15,921.60 (as of 2018).

The Medicare tax rate is 2.9%. Total self-employment tax rate is, therefore, 12.4% + 2.9% = 15.3% (as of 2018). So, a self-employed person having net income of exactly $128,400 in 2018 would have to remit taxes of $19,645.20 = $128,400 X 0.153. However, earnings above $200,000 ($250,000 for married couples filing jointly) are subject to an additional 0.9% Medicare tax. The Social Security component of the self-employment tax phases out once net income reaches the low six figures, but all net income is subject to the Medicare tax. Self-employed individuals must pay self-employment tax as a condition of receiving Social Security benefits upon retirement.

Self-employment tax is a tax-deductible expense. While the tax gets charged on a taxpayer’s business profit, the IRS lets him or her count the employer half of the self-employment tax, or 7.65% (calculated as half of 15.3%), as a business deduction for purposes of calculating the tax.

Individuals typically pay self-employment tax on 92.35% of their net earnings, not 100%. For example, Ike, who runs a HR Consulting business, calculates his total net income for the year to be $200,000 after business expenses have been deducted. His self-employment tax rate will be assessed on 92.35% x $200,000 = $184,700. Since this amount is above the capped limit, his tax bill will be 15.3% x $128,400 = $19,645.20. Ike can claim an above-the-line deduction for half of his self-employment tax, or $19,461.60 ÷ 2 = $9,730.80. In effect, he gets a refund on the employer portion (6.2% Social Security + 1.45% Medicare = 7.65%) of his self-employment tax.

Workers who are self-employed aren't subject to withholding tax, but the IRS requires taxpayers to make quarterly estimated tax payments in order to cover their self-employment tax obligation. Self-employed people who make less than $400 from self-employment don't have to pay any tax.

Self-employment tax is computed and reported on IRS Form 1040 Schedule SE.