What is self-employment tax, and how do I figure out how much I owe?
The self-employment tax, aka the SE or SECA (Self-Employment Contributions Act) tax, is essentially the same as the FICA tax that is paid by employers and employees for Social Security and Medicare. However, if you are newly self-employed, you might be unpleasantly surprised to find out that you will have to pay significantly more in taxes as a self-employed person than as an employee. That's because you are required to pay the full amount of Social Security and Medicare taxes, which is typically split between traditional employees and their employer.
There are three parts of the self-employment tax that individuals must pay:
- 12.4 percent Social Security tax. For 2013, this tax applies to the first $113,700 of net profit or earnings from self-employment. Anything above that (from either self-employment or a regular job) is not subject to this tax.
- 2.9 percent Medicare tax. The Medicare portion of the self-employment tax applies to all earnings from self-employment and all wages from traditional employments — there is no earnings limit like there is for the Social Security tax.
- 0.9 percent additional Medicare tax for higher-earning individuals. This tax is new for 2013 and is a product of the Affordable Care Act, or Obamacare. It applies to income from self-employment and/or wages that exceed $200,000 for single filers and $250,000 for married filers.
If you are a small business and are not incorporated or a legal partnership, then you report your net profit or income on a Schedule C and include this with your Form 1040. You calculate your self-employment tax on Schedule SE and report that amount in the Other Taxes section of Form 1040. Click here for instructions on using the SE form. To get a rough idea of what you might owe in self-employment taxes, click here.
Keep in mind that these self-employment taxes, which can add up to more than 16 percent, are in addition to income taxes imposed by the federal and most state governments. The good news is that there are a few ways you can reduce your tax liability, including structuring your business in a certain way and keeping close track of your business expenses for potential deductions.
Being self-employed can offer wonderful benefits, including flexibility, independence and unlimited income potential. However, it also comes with added responsibility, especially when it comes to paying taxes. You can lighten this burden by making quarterly payments of estimated taxes throughout the year, which may help you avoid additional penalties for underpaying. Hiring a qualified business accountant can also be a smart investment that pays off in stress relief and greater tax savings.