What Is Self-Employment Tax?
Understanding the Basics
Self-employment tax is a tax that the self-employed need to pay. This tax is essentially a combination of Social Security and Medicare taxes that employees would normally have taken out of their paycheck. The self-employed are responsible for both the employer and employee portion of the taxes.
Who Has to Pay Self-Employment Tax?
Most people who are self-employed are required to pay self-employment tax. This includes sole proprietors, independent contractors, members of limited liability companies (LLCs), and those who earn income from rental activities. Those who earn more than $400 a year must pay self-employment tax.
How Is Self-Employment Tax Calculated?
The amount of self-employment tax owed is calculated by multiplying the self-employment income by 92.35%. This number is the total of the 15.3% Social Security and Medicare tax rate as well as the 2.9% Medicare tax rate. For example, if a self-employed person earns $30,000 in self-employment income, then they would owe $27,705 in self-employment tax ($30,000 x 92.35%).
How Is Self-Employment Tax Reported?
Self-employed individuals must report their self-employment tax on their federal income tax return. This is done by filing Schedule SE and completing Part I of the form which calculates the amount of self-employment tax owed.
Are There Any Deductions or Credits to Reduce Self-Employment Tax?
The self-employed may be able to take advantage of certain deductions or credits to reduce the amount of self-employment tax they owe. This includes deductions for health insurance premiums, business expenses, and retirement contributions. Additionally, self-employed individuals may be eligible for the Earned Income Tax Credit which can help reduce the amount of self-employment tax owed.
How Is Self-Employment Tax Paid?
Self-employment tax is usually paid quarterly via estimated tax payments. This means that the self-employed must make quarterly payments throughout the year to cover their self-employment tax liability. Alternatively, self-employed individuals can choose to pay the entire amount when they file their taxes.
What Happens If You Don't Pay Self-Employment Tax?
If you don't pay your self-employment tax, you can face serious consequences from the IRS. The IRS can assess penalties and interest on unpaid taxes, and you may even face criminal charges if you willfully don't pay your taxes.
Conclusion
Self-employment tax is an important tax for the self-employed to understand. It is essentially a combination of Social Security and Medicare taxes, and the self-employed are responsible for both the employer and employee portion of the taxes. Those who earn more than $400 a year must pay self-employment tax, and it is usually paid quarterly via estimated tax payments.