Self-employment taxes can be a confusing and often overlooked aspect of working for oneself in the United States. Many individuals who are self-employed, like freelancers and solopreneurs may not fully understand their tax obligations and may end up facing penalties or fines as a result. We will explore the definition of self-employment taxes, how they are calculated, and what steps self-employed individuals can take to ensure they are meeting their tax obligations.
What are self-employment taxes?
Self-employment taxes are the taxes that self-employed individuals are required to pay to fund Social Security and Medicare. These taxes are similar to the payroll taxes that are automatically withheld from the paychecks of employees, but self-employed individuals are responsible for both the employee and employer portions of these taxes. These taxes are in addition to the income taxes that all individuals are required to pay.
How to calculate self-employment taxes
Self-employment taxes are calculated based on the net income from self-employment.
- The net income is determined by subtracting allowable business expenses from the total income.
- Self-employed individuals are responsible for a 12.4% Social Security tax on their net earnings, but it applies only up to a maximum limit of $160,200 for the year. This means that if your net earnings exceed $160,200, you won't owe Social Security tax on the excess amount.
- Self-employed individuals continue to pay a 2.9% Medicare tax on their entire net earnings, with no cap or limit. However, there is still an additional 0.9% Medicare tax on net earnings over certain income thresholds ($200,000 for individuals, $250,000 for married couples filing jointly).
- Together, these make up the total self-employment tax rate at 15.3% of the net income.
Who is subject to self-employment taxes?
Self-employed individuals who have a net income of $400 or more are subject to self-employment taxes. This includes individuals who are sole proprietors, independent contractors, and freelancers.
How to pay self-employment taxes?
Estimated tax payments
Self-employed individuals like freelancers and sole proprietors are required to make estimated tax payments throughout the year. These payments are made quarterly and are based on the expected income for the year. Quarterly payments are roughly due in January, April, June and September each year. Failure to make estimated quarterly tax payments can result in penalties and interest. Freelancers and other independent workers can use platforms such as Opolis which remove the burden of calculating quarterly taxes. Platforms such as Opolis withhold and remit taxes on behalf of the freelancer's business entity, thus ensuring the tax man gets his fair share at the right time.
Self-employment tax form
Self-employed individuals must report their self-employment income and calculate their taxes on Schedule SE (Form 1040). This form is filed along with the individual's annual income tax return.
Deductions and credits for self-employed individuals
Self-employed individuals are eligible for various deductions that can help reduce their taxable income. Common deductions include business expenses, home office expenses, and health insurance premiums.
Self-employed health insurance deduction
Self-employed individuals who pay for their own health insurance may be eligible for a deduction. This deduction allows self-employed individuals to deduct the cost of health insurance premiums from their self-employment income.
Understanding self-employment taxes is crucial for self-employed individuals to avoid penalties and ensure compliance with tax laws. By knowing what these taxes are, how they are calculated, and what deductions and credits are available, self-employed individuals can better manage their tax obligations and maximize their tax savings.