Self-Employment Social Security Tax
If tax season has you overwhelmed, you are not alone. Every year, millions of small business owners and independent contractors must file and pay self-employment tax. Get a handle on your tax liability by learning what self-employment tax is, how to calculate it, and when it is due.
What is self-employment tax?
Contrary to a common misconception, this tax category only applies to Social Security and Medicare taxes. It does not include income tax levied on self-employment income. Social Security tax is levied on the first $118,500 earned at a rate of 6.2 percent. Medicare tax does not have a ceiling and is calculated at a rate of 1.45 percent.
An employer pays payroll tax by matching the amounts withheld from employee paychecks. The company combines both portions before sending it to the Internal Revenue Service (IRS). However, as a sole proprietor, independent contractor or small business owner, you must pay both the employer payroll tax and the employee tax. This means that you will pay 12.4 percent Social Security tax on the covered portion of your earnings and 2.9 percent Medicare tax on all earnings.
An additional Medicare tax of 0.9 percent is assessed if your income crosses a certain threshold. This additional tax applies to self-employed individuals who make over $200,000 annually and married-filing-jointly taxpayers who make over $250,000 per year.
Determining who must pay self-employment tax
You are self-employed if you meet any of the following criteria.
- You are part of a business or trade partnership
- You are an independent contractor or sole proprietor
- You are in business for yourself, whether part-time or full-time
Although church employees are not technically self-employed, their employer is tax exempt and does not pay Social Security or Medicare taxes. Therefore, they must pay self-employment tax on income over $108.28 or more.
All other individuals with self-employment income must pay self-employment tax on net earnings of over $400 per year. Receiving Social Security or Medicare assistance does not exempt you from paying self-employment tax if you fit the above criteria.
Social Security work credits
Paying Social Security tax on net earnings helps you accrue work credits, which are used to determine eligibility for Social Security benefits. Self-employed workers earn Social Security work credits at the same rate as corporate employees. You earn one work credit for every $1,220 of income, up to a maximum of four credits per year. It takes about ten years of work, or 40 work credits, for a person to be eligible for Social Security benefits.
Calculating taxable income
Self-employment tax is only assessed on net earnings. Calculate your net earnings by subtracting your expenses for the year from the money you earned during the same period. Not all expenses are deductible. You typically cannot deduct the cost of running a home office if the room doubles as a bedroom or living area.
Fill out Schedule C of Form 1040 to calculate net profit or loss. Some small businesses and independent contractors may be able to file Schedule C-EZ instead, provided their expenses for the year are under $5,000. Once you have determined your net earnings or loss, use Schedule SE to calculate and report the amount of self-employed tax you owe.
Deciding whether you must pay estimated tax payments
Since you do not have an employer withholding amounts from your paycheck, you may be required to make quarterly estimated tax payments. You must use this tax payment method if you fit the following criteria.
- You expect to owe over $1,000 in tax for the current year after deducting withholding and refundable credits.
- Your combined withholding and refundable credits will be less than the smaller of either 90 percent of the tax you owe this year, or 100 percent of the tax you owed last year.
Note: Farmers, fishermen, and taxpayers with higher incomes may be subject to different guidelines.
To put this into practical terms, imagine that John Jones owes $1,500 in taxes. He can deduct $500 in withholding and refundable credits. Last year, John only paid $800 in taxes. This year, his tax bill is $1,000. Since the amount John can deduct this year is less than last year’s tax bill, he must make estimated tax payments for the next year.
Making estimated tax payments
Use Form 1040-ES to determine your estimated tax payments for the year. The form includes blank vouchers that can be used to mail in your payments. You may opt to pay through the Electronic Federal Tax Payment System. If your earnings are higher or lower than projected for an individual quarter, recalculate and refile Form 1040-ES to adjust the amount. You must have a Social Security number or an individual taxpayer identification number to make estimated tax payments.
Estimated tax due dates
Each of the four tax periods has a specific due date. If the deadline falls on a holiday, Saturday or Sunday, the payment is on time if it is received on the following non-holiday weekday. You must pay a penalty on late estimated tax payments, even if you are owed a refund at the end of the year.
Calendar tax periods and due dates
The regular tax periods and due dates are as follows.
- For Jan 1 – March 31, the due date is April 18
- For April 1 – May 31, the due date is June 15
- For June 1 – August 31, the due date is September 15
- For September 1 – December 31, the due date is January 17 of the following year
However, there is an exception to the final due date. If you file form 1040 or 1040A and pay the full amount of the tax you owe for the year by January 31, 2017, you do not have to make the January 17 payment.
Fiscal year periods and due dates
Some businesses opt to calculate payments on a fiscal year cycle rather than a calendar year. If you use a fiscal cycle, you must pay estimated taxes on the fifteenth day of your fourth, sixth, and ninth month of your fiscal year. Your final payment is due on the fifteenth day of the first month after the end of your fiscal year. As with standard due dates, you do not have to make the last payment if you file your income taxes by the last day of the first month of your next fiscal year and pay the full amount you owe.
For example, if your fiscal year begins October 1, your end-of-year payment would be due October 15. However, you are not required to pay the last estimated tax payment if you file your taxes by October 31 and pay your full tax bill.
Applying tax deductions
Self-employment tax deduction
Although self-employed individuals are paying a higher tax rate, a portion of it is tax deductible. You may deduct the employer-equivalent portion of the self-employment tax from your gross income. However, this deduction only affects income taxes. It does not reduce your net earnings from self-employment income or the amount of self-employment tax you owe.
Your self-employment tax deduction will be roughly half of your calculated self-employment tax liability. In other words, if you owe $500 in self-employment tax, you may take around $250 as a deduction to your gross income. However, do not rely on this method for figuring your deduction. Follow the instructions on Form 1040 to calculate the accurate amount.
Health insurance tax deduction
Self-employed taxpayers may deduct health insurance costs from their gross income. Unlike the previous deduction, the health insurance tax deduction does affect net earnings and reduces the amount owed for self-employment tax. Use the instructions in Form 1040 and Schedule SE to calculate the amount of this deduction.
Different rules apply to people in certain professions. For instance, farmers and fishermen calculate self-employment tax liability differently than other sole proprietors or small businesses.
Caregivers who have a business will report income paid to them from the state or an insurance company as self-employment income. For example, if a caregiver runs a home business, the income she receives is considered self-employment income. However, if the caregiver is not self-employed, they will not be required to pay self-employment tax.
Tax preparation is different for every person. If you have questions or would like a detailed explanation of how certain tax statutes apply to you, consider asking a tax Expert for their opinion.