Self-Employment Tax

What Is the Self-Employment Tax?

The term self-employment tax refers to taxes self-employed individuals and small business owners pay to the federal government to fund Medicare and Social Security. The self-employment tax is similar to FICA taxes that are paid by an employer. It is due when an individual has net earnings of $400 or more in self-employment income over the course of the tax year or $108.28 or more from a tax-exempt church. The tax is computed and reported on IRS Form 1040 Schedule SE. Individuals who make less than these thresholds from self-employment don’t have to pay any tax.

Key Takeaways

  • Self-employment tax is collected from self-employed individuals and small business owners who don't otherwise pay withholding taxes.
  • The self-employment tax pays for Social Security and Medicare and is reported on IRS Form 1040 Schedule SE.
  • Workers who are considered self-employed include sole proprietors, freelancers, and independent contractors who carry on a trade or business.
  • Individuals who are self-employed and earn less than $400 a year (or less than $108.28 from a church) are exempt from paying the self-employment tax.
  • The CARES Act defers payment of the employer portion of 2020 Social Security taxes to 2021 and 2022.

How the Self-Employment Tax Works

The self-employment tax is designed to be collected from workers who are considered self-employed and don't otherwise pay withholding taxes. 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 (IRS). Self-employed individuals must pay self-employment tax as a condition of receiving Social Security benefits upon retirement.

In any business, both the company and the employee are taxed to pay for the two major social welfare programs: Medicare and Social Security. In the eyes of the IRS, individuals who are self-employed are considered both the company and the employee, which is why they must pay both portions of this tax. Here's how it works.

Social Security tax is assessed at a rate of 6.2% for an employer and 6.2% for the employee. Therefore, a self-employed worker is taxed 6.2% + 6.2% = 12.4%, as they are considered to be both an employer and an employee. The Social Security tax is only applied to the first $142,800 of self-employment income earned, for a maximum tax of $17,707.20 in 2021. That amount increases for 2022 and is only applied to the first $147,000 of income for a total tax of $18,228.

Medicare tax is assessed at a rate of 1.45% for an employer and 1.45% for the employee. Therefore, a self-employed worker is taxed 1.45% + 1.45% = 2.9%, as they are considered to be both an employer and an employee. There is no income limit for Medicare taxes. Total self-employment tax rate is, therefore, 12.4% + 2.9% = 15.3%. A self-employed person with a total net income of exactly $137,700 in 2021 would have to remit taxes of $21,068.10 ($137,700 x 15.3%).

Self-employment tax is a tax-deductible expense. While the tax is charged on a taxpayer’s business profit, the IRS lets them 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 that taxpayer's income tax.

Special Considerations

Workers who are self-employed aren’t subject to the withholding tax. As such, the IRS requires taxpayers to make quarterly estimated tax payments in order to cover their self-employment tax obligation, in addition to their federal and state income tax obligation.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act, signed into law by President Donald Trump on March 27, 2020, defers payment of the employer portion of self-employment taxes attributable to Social Security for the period of March 27, 2020, through Dec. 31, 2020. It defers payment of 50% of those taxes until Dec. 31, 2021, and the other 50% until Dec. 31, 2022.

High-income earners face an additional self-employment tax. As a result of the Affordable Care Act (ACA) earnings above $200,000 ($250,000 for married couples filing jointly) are subject to an additional 0.9% Medicare tax.

Example of the Self-Employment Tax

Contrary to what you may think, individuals typically pay self-employment tax on 92.35% of their net earnings—not on 100% of their full earnings. Here's how it works.

Let's say an individual runs a human resource consulting business and calculates their total net income for 2021 as $200,000 after business expenses are deducted. Their self-employment tax will be assessed on 92.35% of this amount $200,000 for a total of $184,700. This amount is above the capped limit for the Social Security portion of the self-employment tax. Therefore, Robin's self-employment tax bill will be $23,063.50. We arrive at this figure as:

($142,800 x 12.4%) + ($184,700 x 2.9%)
$17,707.20 + $5,356.30

When filing their 2021 income tax return, they can claim an above-the-line deduction for half of their self-employment tax, or $23,063.50 ÷ 2 = $11,531.75. In effect, they get a deduction on the "employer" portion (6.2% Social Security + 1.45% Medicare = 7.65%) of their self-employment tax.

Article Sources
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  1. Internal Revenue Service. "Topic No. 554 Self-Employment Tax."

  2. Internal Revenue Service. "Topic No. 751 Social Security and Medicare Withholding Rates."

  3. Social Security Administration. "2022 SOCIAL SECURITY CHANGES."

  4. Social Security Administration. "Contribution and Benefit Base."

  5. Internal Revenue Service. "Publication 334, Tax Guide for Small Business (For Individuals Who Use Schedule C)," Page 9.

  6. Internal Revenue Service. "Self-Employed Individuals Tax Center."

  7. U.S. Congress."H.R.748 - CARES Act."

  8. Internal Revenue Service. "Questions and Answers for the Additional Medicare Tax: When Are Individuals Liable for Additional Medicare Tax?"

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