Self-Employment Tax: What Is It And How Do You Calculate It?

Marcus Carlson - 2020-10-26T22:00:00.000Z

With over 16 million people working for themselves in the United States, many accounting and tax concerns have surfaced. Entrepreneurial niches have widened our wage-earning horizons, but they’re still not wide enough to set us free from the strings of taxes. Self-employment (SE) tax is one cost of doing business that entrepreneurs are intimately familiar with.

How Self-Employment Tax Works

First off, let’s begin by answering what self-employment tax is.

Citizens who own independent businesses are required to file an annual individual tax return. Whether you're self-employed, a sole proprietor, or the owner of a limited liability company, you’ll be required to file and pay. Ultimately, these SE taxes fund the taxpayer’s Medicare and Social Security contributions.

The Internal Revenue Service is that SE taxes are designed to ensure freelancers and sole proprietors receive social benefits after retirement. Unlike ordinary wage earners who see these contributions automatically deducted from paychecks, entrepreneurs and small business owners with a net income of at least $400 by the end of the year must file and pay this individual contribution.

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Who Pays Self-Employment Tax?

This contribution is levied upon sole-proprietors and self-employed contractors. In other words, it’s incumbent on all those who own a business that hasn’t been incorporated to pay this tax.

As mentioned earlier, individuals who fall under this category and earn above $400 annually are obligated to pay this contribution regardless of their age or the social benefits they’re already receiving. For church employees that fall under this category, the taxable income must exceed $108.28.

The net income, on which self-employment tax is based, is calculated according to total annual revenues minus expenses and associated investment costs. Apart from this income, the taxable amount also includes earnings that arose from the following areas:

Owning a business
Farming
A profession
Rentals
Partnerships
A trade
An undertaking
A trading venture
Fishing

How Much Is Self-Employment Tax?

The self-employment tax rate amounts to 15.3% of your year-end earnings. Of this amount, 12.4% is allocated to Social Security while the remaining 2.9% is directed to Medicare.

The Self-Employed Contributions Act first made this contribution mandatory for individual workers. The logic behind this move was ensuring these workers would be entitled to retirement security and disability benefits. The Social Security charge is levied on the first $137,700 in the current year, which caps the total SE tax contribution for this item at $17,074.80.

Unlike the Social Security charge, Medicare is the national medical insurance program charge that’s applied to your combined net income. For earners whose income exceeds $200,000, there’s an additional contribution amounting to 0.9%.

When You Should Pay Self-Employment Tax?

Payment can sometimes take the form of multiple installments.

April 15^this the usual date to file in the US, meaning your SE tax is paid alongside your personal annual tax filing. However, you can request an extension in case you need one. Due to the COVID pandemic, the deadline to file was automatically extended to July 15^th.

Beyond handling this once annually, you can file quarterly payments until the middle of April, June, September, and January to spread out payments. These deadlines have also undergone adjustments after an extension to July 15^th, 2020, for the first two payments.

How To Calculate Self-Employment Tax

The following formula can easily help you calculate the amount due.

Self-employment tax = net income x 15.3%

While the amount levied on the first $137,700 is the same regardless of age or earnings, things start to get trickier if your year-end income exceeds this amount. In that case, you’ll be subjected to a different rate based on income.

Relying on a simple formula may not be possible anymore. You must gather your yearly figures and subject them to a tax calculator. Bench.co's quarterly calculator is a popular invoicing tool that can assemble the taxable numbers with some basic input.

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How To Pay This Tax If You’re Self-Employed

Self-employment taxes require a Social Security number (SSN), an employer identification number (EIN), and a taxpayer identification number (ITIN) before you begin filing. Second, you must fill out the forms mentioned below.

Schedule SE or form 1040 to help the security administration estimate your benefits
Schedule C that accounts for your entrepreneurial profits and losses
Form 8959 to estimate any additional Medicare charges
Form 1040-ES helps to estimate the quarterly tax contribution

After filing, you can use one of the following ways to make payments:

Online payment services
Pay through the Electronic Federal Tax Payment System
Electronic funds transfer
Check or money order sent via mail
Wire transfer
Pay in cash with a variable convenience fee included
IRS2Go Mobile app

How Can You Reduce The SE Tax?

It’s possible to increase deductions legally. You may try any one of the following methods depending on your entrepreneurial niche:

Keeping tabs on your accounts: The deductions for the year 2015 alone amounted to a staggering $1.1 trillion. Now you can benefit from these deductions too. However, don’t expect the IRS to walk you by the hand through your accounts to sniff out areas to shrink contributions. You’ll need to separate and categorize private and business expenses

Reducing the adjusted gross income: Call this an above-the-line deduction. You can reduce the adjusted gross income and ultimately the tax by including costs of utilities, rent, equipment, supplies, insurance, legal assistance, salaries, and so forth
Elect to register an S-corp: This option allows you to save 14.13% of each taxable dollar that you earn.

Integrate a reputable accounting software solution: Filed contribution can be paid monthly through a payroll service. Integrating with reputable accounting software can help automate the process with timely payments. This also improves your standings with the tax authorities

Borrow professional help: Hiring an accountant isn’t uncommon for businesses. These professionals can help with tariff reductions in various ways

The Bottom Line

As a contractor, freelancer, or sole-proprietor, familiarity with self-employment tax and when to pay can be integral for your business’s scalability. Keeping yourself informed is the first step toward managing your accounts properly while making the most of tax returns and maximizing deductions to improve overall income and profitability.