Wouldn’t it be nice to be your own boss? You’d get to set your own hours, decide what work to take on and do only what you want to do. While you may be able to avoid someone else telling you what to do as a self-employed individual, you can’t avoid paying your taxes. In fact, self-employed individuals often have to pay more in taxes than someone who is a W-2 wage earner. This additional tax burden is called the self-employment tax.
What Is the Self-Employment Tax?
The self-employment tax, officially referred to as the Self-Employment Contributions Act tax, is a type of payroll tax. The self-employment tax is actually a combination of two taxes: there’s 12.4% for Social Security and 2.9% for Medicare. This adds up to a 15.3% tax on the income of self-employed individuals.
Who Has to Pay the Self-Employment Tax?
Any taxpayer who has net earnings from self-employment amounting to $400 or more (excluding church employee income) is subject to the self-employment tax. Individuals who have church employee income exceeding about $110 may also be subject to this tax, as well.
In most cases, someone is considered self-employed by the IRS if they run a business as a sole proprietor.
Why do Self-Employed Taxpayers Have to Pay This Tax?
The truth is that the 15.3% Social Security and Medicare Tax is paid by all employers. For a taxpayer who is a W-2 wage earner, his or her employer pays half of the self-employment tax themselves. In this situation, the employee and the employer both pay half of the 15.3% tax. For someone who is self-employed, they are both the employee and the employer, so they get stuck paying the entire 15.3% self-employment tax.
Some Good News Regarding the Self-Employment Tax
There is a little bit of good news for self-employed individuals in that they rarely have to pay the full 15.3% of their gross income.
First, in most situations, only 92.35% of a self-employed taxpayer’s income is subject to the 15.3% tax. So if a taxpayer has $100,000 in self-employment income, only $92,350 is subject to the self-employment tax. This 7.65% reduction in taxable income represents the fact that 50% of the self-employment tax is deductible (half of 15.3% is 7.65%).
Second, there is a cap on how much a taxpayer must pay for the Social Security portion of the self-employment tax. For the 2016 tax year, the 12.4% Social Security tax obligation only applied to the first $127,200 in income (this amount subject to the 12.4% Social Security tax rate changes every year). Anything earned over that amount was not subject to the 12.4% Social Security part of the self-employment tax. Unfortunately, there is no such cap for the 2.9% Medicare portion of the self-employment tax.
Paying the Self-Employment Tax
For most self-employed taxpayers, they will need to pay the self-employment tax every quarter, when paying their quarterly income taxes. For a W-2 wage earner, the employer withholds the necessary taxes and sends it to the federal government. But for someone who is self-employed, they have to send the money to the government themselves, every three months.
The self-employment tax is relatively straightforward, but for some taxpayers, they may be in a gray area as to whether quarterly tax payments are necessary or what types of earnings count as self-employment income. In these situations, it may be a good idea to contact a tax professional.