In this article, you will learn:
If you are someone who works for yourself rather than an outside company, you are a self-employed person in the eyes of the IRS. All US citizens or US residents as per the Internal Revenue Code making self-employment income from personal services are self-employed persons as per IRS and need to pay self-employment tax on such self-employment income.
A self-employed person is typically liable to pay Self-employment Tax (SE Tax) as well as federal income tax on his net earnings during the calendar year.
Accordingly, all freelancers, independent contractors, and small business owners who carry out a trade or a business come under the self-employed category and are typically required to pay both federal income tax and SE tax as per IRS.
Keep reading if you are self-employed as in this article, we’ll help you know what is Self-Employment tax, who must pay SE tax, Schedule SE form, SE tax rate, and how to file SE tax with the IRS. But before jumping to the SE tax, let’s first understand who is self-employed as per IRS.
Are You Self-Employed?
According to the IRS, you are a self-employed individual if you are:
- into a trade or business as a sole proprietor or an independent contractor
- a member of a partnership that is into a business or trade (including multi-member LLC treated as a partnership for federal tax purposes)
- into a business for yourself including gig work or part-time business
Please note that sole proprietor also includes a member of a single-member LLC and a member of a qualified joint venture. As you can see, you don’t have to be carrying out a regular, full-time business to be self-employed as per IRS.
You could be into a part-time business such as a gig worker along with a regular job or business and still be considered self-employed. Accordingly, all freelancers, independent contractors like doctors, lawyers, accountants, etc, and small business owners are considered self-employed by the IRS.
What is Self-Employment Contributions Act (SECA) Tax?
SECA tax, also called SE tax, is a Social Security and a Medicare Tax for self-employed individuals. This is much like Social Security and Medicare Taxes of the wage earners that are withheld by their employers.
Persons who work for themselves and not for any outside company pay SE tax to the IRS to contribute towards their coverage under the Social Security System.
Thus, Social Security benefits are available to self-employed persons much like wage earners. Where employers withhold taxes from employee earnings to fund Social Security and Medicare programs for these wage earners, the self-employed’s payments in SE tax contribute to his coverage under Social Security System.
Social Security coverage offers you multiple benefits such as retirement benefits, survivor benefits, disability benefits, and hospital insurance benefits. However, you must report all your self-employment earnings if you need to claim the full benefit of your social security coverage.
Additionally, you need to be insured before you can begin to receive your social security benefits. Being insured means earning requisite credits to be able to receive your social security benefits.
You must consult a Social Security Agent (SSA) to know the number of credits you must have to be insured and your social security benefits.
Who Must Pay SE Tax?
You are bound as a self-employed to pay SE tax and file form 1040 Schedule SE if any of the following applies to you:
- your net earnings, excluding the church employee income, is $400 or more
- your church employee income is $108.28 or more
Paying Self-Employment Tax: How Much?
Typically, 92.35% of your net earnings from self-employment are subject to SE tax. The net earnings are deduced by subtracting ordinary and necessary business and trade expenses from the gross income that you earn from your trade or business.
The SE tax rate set by IRS is 15.3% which is bifurcated as follows:
- 12.4% for Social Tax
- 2.9% for Medicare Tax
You must note that the IRS has also kept a cap on the maximum net earnings that are subject to SE tax.
Maximum Net Earnings Subject to SE Tax
As per IRS, only the first $147,000 is subject to the Social Security portion of the SE Tax. This means that if 92.35% of your net earnings exceed $147,000, you must charge 12.4% on $147,000 to calculate the Social Security tax portion of the SE tax and not on your net earnings (that is 92.35% x net earnings).
However, all your net earnings (92.35% x net earnings) are subject to the Medicare part of the SE tax. Let’s take an example here to understand how you can calculate self-employment tax.
Self-Employment Tax Example
Say you are an independent accountant whose net earnings for 2022 come out to be $3,50,000 after subtracting business expenses. Let’s see the steps you’ll follow to calculate your self-employment tax.
Step 1: Net Earnings Subject to SE Tax
Net Earnings Subject to SE Tax = 92.35% x $3,50,000 = $323,225
Step 2: Net Earnings Subject to Social Security Part of the SE Tax
Our net earnings subject to the Social Security part of SE tax as calculated in the above step are $323,225. Since this amount is more than $147,000, the capped limit set by the IRS for the Social Security part of the SE tax, we will take $147,000 and charge 12.4% on it.
Accordingly, the Social Security part of the SE tax = 12.4% x $147,000 = $18228
Step 3: Net Earnings Subject to Medicare Part of the SE Tax
Since all your net earnings (92.35% x net earnings) are subject to the Medicare part of the SE tax, the Medicare Tax part of the SE tax in this case is as follows.
Medicare Tax part of the SE tax = 2.9% x $323,225 = $9373.525
Therefore, SE tax amount payable = $27,601.525
Deduction for One-Half of Self Employment Tax
As a self-employed individual, you can claim a deduction for one-half of the self-employment tax at the time of filing your income tax return with the IRS. Going by the above example, your SE tax deduction would be as follows:
SE Tax Deduction = $27,601.525 ÷ 2 = $13800.7625
Additional Medicare Tax
You’ll be subject to 0.9% additional Medicare Tax if the net earnings from your self-employment exceed the following limits set by the IRS. These thresholds vary based on your filing status.
|Your Filing Status||Net Earnings Is More Than|
|Married filing jointly||$250,000|
|Married filing separately||$125,000|
|Single, head of the household, or qualifying surviving spouse||$200,000|
Filing Tax Returns
As mentioned earlier, you are bound to pay both self-employment tax and federal income tax with the IRS if you meet the filing requirements.
SE tax is the Social Security Tax and Medicare Tax that you pay on your net earnings to contribute towards your social security coverage as a self-employed. This is payable if your net earnings from self-employment are $400 or more. Whereas, the income tax is the tax you pay on your gross income as per income tax brackets set by the IRS. To know if you meet the requisite income tax filing requirements, you must check the income tax brackets set for taxpayers.
As a self-employed individual, you will file an income tax return with IRS if you meet the filing requirements.
1. Form 1040 for Income Tax Return
You will use Form 1040 or 1040-SR to calculate your individual taxable income as well as the tax payable as an individual. The due date for filing this return is the 15th day of the fourth month after the end of the tax year.
2. 1040 Schedule C
In order to calculate the taxable income in Form 1040, you’ll need net income from your business. 1040 Schedule C is used to calculate the net income from your business and is reported on Form 1040, line 3, as well as on line 2 of 1040 Schedule SE. Thus, 1040 Schedule C is attached with Form 1040 when filing your income tax return. Since this is filed with Form 1040, the due date for filing 1040 Schedule C is the 15th day of the fourth month after the end of the tax year.
3. 1040 SE
Since you are a self-employed person, you’ll be bound to pay SE tax if your net earnings are $400 or more. To calculate your SE tax, you’ll use 1040 Schedule SE. 1040 SE is also filed with Form 1040 or 1040-SR on the 15th day of the fourth month after the end of the tax year.
Remember, that the federal income tax is a pay-as-you-go tax. That is, income tax is paid the moment you earn or receive payments during the year. There are two ways to pay as you go which are as follows:
a. Withholding Tax
In the case of wage earners, the employers withhold tax from their pay, and the amount withheld is paid by the employer in the name of the respective employees. Since you are not a wage earner, you’ll pay income tax via Estimated Tax.
b. Estimated Tax
If the income tax is not paid via withholding or if sufficient tax is not paid through this method, individuals are required to pay an estimated tax. Typically, people who are self-employed are required to pay their income tax via estimated tax. Apart from the income tax, even the Self-Employment Tax and the Minimum Alternative Tax are also paid through this method using Form 1040-ES.