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March 31, 2022

What Is Self-Employment Tax

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Many taxpayers have to pay self-employment tax, but what exactly does it mean? Its rate consists of Medicare and Social Security tax rates.

Self-employed individuals have to pay this tax in most cases. Typically, independent contractors, freelancers, small business owners, and others fall under this category. Keep reading the article to learn more about the topic, study how to calculate and how much you have to pay for your earnings.

Understanding Self-Employment Tax

The self-employed tax rate is 15.3%. As mentioned, it’s a combination of Medicare which is 2.9% and Social Security, which is 12.4%. In addition they give 15.3%.

The mentioned rate applies to net earnings. The net income is the profit a person makes in a year. In some cases, people pay this tax once a year during the tax season. In others, taxpayers must calculate their estimated tax payments that include self-employment taxes. As a result, they pay four times a year.

Taxpayers pay differently according to the type of their employment. Self-employed pay as mentioned — four times a year. But salaried employees pay differently. Their employers withhold taxes from their paychecks.

Another difference is that employees on a payroll don’t have to pay their Social Security and Medicare tax in full. Instead, the employee and their employee split the burden, and each pays 7.65%.

Self-Employment Tax Rate for 2021-2022 Period

It’s worth mentioning that self-employment and income taxes are two different types of taxes. Here are some of the key takeaways:

  • The first $142,800 of taxpayer’s income is subject to the Social Security portion for the year 2021. In the following year, it should increase to $147,000.
  • Self-employed individuals filing as single taxpayers pay an additional 0.9% tax rate on their net earnings if they earn $200,000 or more. If a filer is married or files jointly and earns $250,000 or more, they also have to pay this additional tax rate.
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Calculating Self-Employment Tax

A taxpayer has to determine their net earnings from self-employment during one financial year to calculate how much they must pay. Here is how you do it:

  • Net earnings is gross income generated through self-employment but after claiming all business deductions. Let’s assume a taxpayer, Susan, has earned $40,000 this year.
  • Typically, 92.35% of a taxpayer’s net earnings are subject to self-employment tax. So, Susan has to multiply her income of $40,000 by 92.35% to get a taxable income of $36,940.
  • The next step is to apply 15.3% to the taxable income. Susan has a taxable income of $36,940, so she multiplies it by 15.3% to get $5,652.

Keep in mind that in 2021 only the first $142,800 of earnings are taxable. The exceeding income isn’t subject to the Social Security portion of self-employment tax. In 2022, taxable income is first $147,000.

Make sure to check the IRS that offers filing rules. Generally, you have to pay self-employment tax when earning $400 or more within a year.

What Is Self-Employment Tax

Who has to Pay?

Typically, the IRS recognizes the following groups of people who have to pay self-employment tax:

  • Taxpayers who gained $400 or more in net earnings through self-employment. The exception includes taxpayers who earn as church employees. If the IRS has information from entities that you worked for, and you get a 1099 form from this entity, you are most likely to pay the self-employment tax.
  • Taxpayers who are church employees earn $108.28 or more in earnings.

These rules are in effect no matter your age or whether you receive Medicare service or Social Security aid.

How to Pay?

The first step is to use the IRS Schedule C to determine net earnings from self-employment. Then you have to determine your taxable income. Only then to calculate the self-employment tax by using the IRS Schedule SE.

Taxpayers may also use our example in the article above. Or use other options, such as online products (calculators). When filing, make sure to add a Social Security number or individual taxpayer identification number (ITIN).

Make sure to pay on time and regularly. Salaried employees don’t have to worry about penalties and deadlines throughout the year since their employers take care of paying taxes. Self-employed taxpayers have to determine their estimated tax payments and pay every quarter of the year. Check the official IRS website to see all due dates.

A taxpayer is expected to make estimated quarterly payments if they:

  • Will owe at least $1,000 in federal income taxes during a financial year. The number reflects income upon accounting for their withholding and refundable credits.
  • Have refundable and withholding credits covering less than 90% of their tax liability for a current financial year or 100% of their liability the previous year.

Note, in the last case, the threshold is 110% for taxpayers who earned more than $75,000 for singles and $150,000 when filing jointly. If you pay more than necessary, you get a refund. But avoid not paying in full since the IRS may fine you.

Self-Employment: Acceptable Deductions

Taxpayers are allowed to deduct half of their self-employment taxes when calculating income taxes. Let’s take Susan’s example. She has calculated her self-employment tax, it is $5,652. She can pay only half, so:

$5,652 / 2 = $2,826

When calculating how much to pay on your returns, don’t forget to claim deductions and credits. For instance, if a taxpayer has a home office, they may deduct rent on the total office space.

If a taxpayer must drive a car to operate a business, they can claim business expenses on a car. Take a look at the IRS official website to find all acceptable tax deductions you can claim to reduce your tax burden.

It is also worth mentioning that in some states, it’s more beneficial to launch a business. When having problems with calculating taxes, feel free to use the services of available accountants or experts.

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Author: Charles Lutwidge

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