A Beginner's Guide to Self-Employment Taxes
Few people can say they like the 9-to-5 workweek. It’s rigid, inflexible, and, unmercifully, falls over the most natural time for humans to sleep: the afternoon siesta.
Consequently, more and more people are considering independent work. Flexible hours, no boss, no dress code — just you and the wide-open playing field. What’s not to love?
I’m sorry you asked. I’d like to introduce you to self-employment tax.
What is self-employment tax?
Self-employment tax — more commonly known as FICA (Federal Insurance Contributions Act) — actually comprises two taxes: Social Security and Medicare.
Technically, all working Americans pay FICA. And I'm not generalizing when I say that! All earned income is subject to it, and the IRS rigidly enforces it. It’s the golden child of the tax code: untouchable by all and a real pain in the butt.
To date, there are only a few exceptions to the requirement to pay this tax. (One of these is church employees who take a literal vow of poverty.) So yes, we all pay it.
The best way to understand self-employment tax is to see how it works on the employee level first. Then, I’ll explain how things are different for self-employed people.
How FICA taxes work for employees
FICA taxes are collected through two channels: the employee and the employer. Here’s how it works on both ends.
The employees’ share of FICA taxes
Throughout the year, FICA is automatically deducted from a W-2 employee’s gross pay and remitted to the IRS in a process called withholding.
Many employees don’t even realize they’re paying FICA taxes! When they receive their W-2s however, the amounts paid in are reported in boxes 4 and 6.
Social Security tax is 6.2%, and it’s assessed on the first $142,800 of earned income. (We’ll come back to this term, but for now just know that it includes your W-2 wages). Income exceeding $142,800 is exempt from Social Security.
Medicare tax is 1.45%, and it’s assessed on all earned income, with no current threshold limits. The combined rate is 7.65%.
The employer’s share of FICA taxes
The employer is required to “match” the FICA taxes paid by their employees. This effectively means they’re paying the same rate, so when an employee hits the maximum taxable threshold for Social Security, the employer also becomes exempt.
The employer portion of FICA is an added cost to having employees, so the IRS allows employers to write off their half of the tax. This part is also relevant for self-employed people — more on that later!
How much is self-employment tax?
Self-employed people are required to pay FICA taxes as well. When they pay it, it’s known as “self-employment tax” — SE tax for short.
All “earned income” is subject to Medicare and Social Security. Earned income is anything you receive in exchange for a product or service.
An employee’s wage, because it’s received in exchange for time and labor. Self-employed individuals cut out the middleman — the boss — and receive their earnings directly from the customers they serve or sell products to.
I mentioned before that the IRS is stingy about FICA tax, and I wasn’t joking. The IRS makes an additional 7.65% off of the middleman that freelancers did away with. So to ensure they still get their cut, the IRS requires freelance workers to pay both the employer and the employee portions of FICA.
In total, the combined self-employment rate for FICA is 15.3%.
Who has to pay self-employment taxes?
All self-employed people, like freelancers, independent contractors, and small business owners are required to pay self-employment taxes. (This is true whether you have a sole proprietorship or a single-member LLC.)
The requirement to pay self-employment tax also extends to W-2 employees who work side hustles. If you drive for Uber only on the weekends or sell the occasional piece of jewelry on Etsy, you’re liable for the full 15.3% — even if FICA taxes are paid through your employer also.
Occasionally taxpayers who work multiple jobs will end up paying more Social Security tax than they’re liable for. In these instances, the IRS will refund the overpaid tax when you file your 1040 tax return.
Lowering your self-employment tax bill
A 15.3% tax rate is a difficult pill to swallow. Especially since it can’t be reduced by any of your regular above-the-line tax deductions, such as student loan interest and retirement contributions, or the standard deduction and your itemized personal deductions. Any leftover “net income” from your business will be taxed at 15.3%, and there’s almost nothing you can do about it.
You can estimate how much you’ll end up paying using our handy-dandy self-employment tax calculator — simply plug in your net income and voila! Your projected tax bill.
Fair warning: Those numbers can be pretty steep. So if you need to step away to stress-eat some Cheetos, go right ahead.
Once the initial shock has passed, let’s consider the options you have to reduce your bill.
The deductible part of self-employment tax
Good news: Half of your self-employment tax is a deduction in and of itself.
If you recall, employers are permitted to write-off their portion of FICA (7.65%) since it’s essentially an added cost of having employees. In the same vein, the additional 7.65% freelancers pay to be their own boss is an eligible write-off against their income taxes.
You’d forgotten about income taxes for a second, huh? Your business income is subject to both income and SE tax.
In general, this isn't great. Say you're in the bottom income tax bracket, the 10% bracket. To find out your total tax liability from both income and SE tax, you'd add that 10% to the 15.3% you're paying in SE tax — resulting in 25.3%. That's just over a fourth of your total income!
Luckily, the employer portion of your SE tax can be used to reduce your income taxes. You’ll deduct half when you fill out Schedule SE.
Business tax deductions you can take
Self-employment taxes are assessed on your net income — meaning, your income after eligible business expenses have been deducted. So the best way to lower your tax bill is to lower your net income by deducting everything you’re spending on running your business.
Anyone self-employed can deduct business expenses: you don’t need an LLC to claim these write-offs. You’ll fill out these expenses on your Schedule C, which self-employed people use to report their income and expenses. Some common business expenses for freelancers and gig workers include:
General rule of thumb: If it’s a necessary cost for your business, you can probably claim it. But to err on the safe side, be sure to use the Keeper Tax app to scan your purchases for qualified write-offs. That way, you’ll never miss an eligible deduction!
Paying your self-employment taxes
Hopefully you were able to come up with a reliable estimate of your tax bill using Keeper’s SE tax calculator.
Armed with this estimate, you can pay the IRS a few different ways: mail the IRS a check, use their Direct Pay feature, or make your payment directly in the Keeper Tax app.
To learn more about the process of filing, take a look at our step-by-step guide on filing self-employment taxes.
Remember, you don’t have to pay this amount all at once! Most people make quarterly estimated tax payments to spread the cost out over the year. (In fact, the IRS will penalize you for not paying quarterly if you’re on track to owe more than $1,000 in taxes!)
To learn more about this process, check out our 411 article on how to file quarterly taxes.
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At Keeper Tax, we’re on a mission to help freelancers overcome the complexity of their taxes. That sometimes leads us to generalize tax advice. Please email firstname.lastname@example.org if you have questions.