Kiah Treece is a former environmental scientist and licensed attorney. Since leaving the legal field in 2018, she has owned and operated numerous small businesses and has developed particular expertise in real estate and finance. She is passionate about entrepreneurship and breaking down complicated topics so readers can make sound decisions about their business and personal finances. In addition to True Self Employment, she has been featured by leading publishers including Forbes, USA Today, and the Los Angeles Times.
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Self-Employment Taxes: What They Are & How They Work
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Self-employment taxes are paid by self-employed individuals and business owners who work for themselves. These are technically Social Security and Medicare (FICA) taxes, half of which are normally paid by employers on behalf of W-2 employees. However, when someone derives self-employment income that isn’t subject to federal withholding, they must pay both halves of their FICA taxes. This difference is currently 7.65%.
While self-employment tax is generally considered to be about 7.65%, the actual rate for an individual taxpayer is based on their net earnings reported on Schedule SE with their federal income tax return.
If you just started earning self-employment income and are going to become responsible for paying both halves of your FICA taxes, it’s important to stay on top of your earnings to be aware of your tax liability throughout the year. One of the best ways to do this is by implementing a solid bookkeeping system for tracking and managing your revenue and expenses. We’ve partnered with leading software
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What are Self-Employment Taxes
Self-employment taxes are the portion of Social Security and Medicare taxes that employers normally pay on their employees’ behalf but that self-employed individuals are required to pay themselves. These taxes are required to be paid by anyone who earns self-employment income, including freelancers, contractors, and small business owners.
Instead of having these taxes withheld from a paycheck like traditional employees, self-employed individuals must estimate their own quarterly taxes and pay them directly to the IRS.
The total rate of FICA taxes is 15.3%. This rate is comprised of two parts: 12.4% for Social Security and 2.9% for Medicare. While W-2 employees typically only pay half of each of these taxes, self-employed individuals must pay them all themselves. This difference is what’s referred to as self-employment tax.
Self-Employment vs. FICA
Federal Insurance Contributions Act (FICA) taxes are generally thought to be the portion of employee paychecks that are withheld for Medicare and Social Security. However, FICA taxes are double the rate rated on employee checks, with employers responsible for paying the other half.
Self-employed individuals, however, are responsible for calculating and paying the full 15.3% self-employment tax to the IRS, usually quarterly.
Additionally, while self-employed individuals can deduct the employer-equivalent portion of their self-employment tax when calculating their adjusted gross income, traditional employees cannot make any deductions related to FICA taxes.
Who Has to Pay Self-Employment Taxes
Self-employment taxes are specifically targeted toward those who earn self-employed income, usually by managing their own businesses or doing freelance work. Here’s a list of individuals who are typically required to pay self-employment taxes:
- Freelancers and independent contractors: Individuals who provide services on a freelance basis or as independent contractors are responsible for paying self-employment taxes.
- Business owners and sole proprietors: If you own a business or are a sole proprietor, you must pay self-employment taxes.
- Members of a partnership: If you’re part of a business partnership, you’re considered self-employed. Partnerships include businesses owned and run by two or more individuals. Every partner must pay self-employment taxes on their share of business income.
- Individuals who earn a certain amount from side gigs: If you earn $400 or more from a side gig in a year, the IRS requires you to pay self-employment taxes on that income.
If you’re unsure whether you’re responsible for paying self-employment taxes, consult a tax advisor or accountant to understand your tax obligations.
Self-Employment Tax Example
Let’s consider an example for a clearer understanding of how self-employment taxes work for freelancers. Suppose a freelance graphic designer earns $60,000 in net income from various projects throughout the tax year. Here’s how the self-employment tax would be calculated (note that these calculations may vary for specific circumstances):
- First, the person’s income is reduced by half of the self-employment tax rate. So, $60,000 - ($60,000 * 15.3% / 2) = $60,000 - $4,590 = $55,410. This amount is the net income adjusted for half of the self-employment tax.
- Self-employment tax is then calculated on this adjusted net income. So, $55,410 * 15.3% = $8,477.73. This is the total self-employment tax owed.
- The IRS allows the graphic designer to deduct the employer-equivalent portion of their self-employment tax in calculating their adjusted gross income. So, the deductible part of the self-employment tax would be $8,477.73 / 2 = $4,238.87.
Thus, the graphic designer has to pay a self-employment tax of $8,477.73, but they can deduct $4,238.87 of this in their personal income tax, potentially reducing their overall tax liability. Please note this calculation does not account for any additional personal exemptions, deductions, or credits the graphic designer may qualify for, which could further reduce the tax liability. Always consult a tax professional for personalized advice.
The True Cost of Self-Employment Taxes
The true cost of self-employment taxes has to be viewed from two perspectives. On the surface, self-employment taxes may seem higher than FICA taxes. This is because self-employed individuals bear the full responsibility of paying the total 15.3% tax, which is the total of both the employee and employer’s portions of FICA. In contrast, traditional employees only see their half of the FICA tax, 7.65%, deducted from their paychecks, with the employer contributing the other half.
However, self-employed individuals can deduct the employer-equivalent portion of their self-employment tax when calculating their adjusted gross income. This means that even though self-employed individuals pay the full 15.3%, they can deduct 7.65% of their income, potentially lowering their overall tax liability. So, while the immediate out-of-pocket tax cost may seem higher, the impact on taxable income is more nuanced and can benefit self-employed individuals.
