Definition
Self-employment tax represents the Social Security and Medicare taxes for individuals who work for themselves. For self-employed individuals, this tax serves to cover their contributions to Social Security (old-age, survivors, and disability insurance) and Medicare (hospital insurance). The combined self-employment tax rate is equal to the total rate that both employee and employer contribute towards FICA (Federal Insurance Contributions Act).
From 2011, the Social Security portion of self-employment tax is 10.4% on net earnings from self-employment up to $106,800, while the Medicare portion is 2.9% on total net earnings from self-employment. Starting from 2012 onwards, the combined self-employment tax rate increased to 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare.
Self-employed individuals are required to pay their self-employment tax on a quarterly basis, along with estimated income tax to the IRS.
Examples
Example 1: Freelance Graphic Designer
Nalanda is a freelance graphic designer and earns a net income of $90,000 in 2021. She is required to pay both Social Security and Medicare taxes via the self-employment tax system. Therefore, she will pay a 15.3% tax (12.4% + 2.9%) on her net earnings.
Example 2: Independent Consultant
Michael is an independent consultant earning $150,000 in 2021. He will pay Social Security tax up to the annual maximum income threshold and Medicare tax on his entire income. Therefore, he will pay Social Security tax on $142,800 (2021’s cap) and Medicare tax on $150,000.
Frequently Asked Questions (FAQs)
What is the self-employment tax rate for 2022?
The self-employment tax rate for 2022 remains at 15.3% of net earnings. This includes 12.4% for Social Security (up to the wage base limit) and 2.9% for Medicare (on all net earnings).
Who is subject to self-employment tax?
Individuals who work for themselves and earn a net income of $400 or more from self-employment activities are subject to the self-employment tax.
When must estimated self-employment tax payments be made?
Self-employed individuals must pay estimated self-employment tax quarterly, typically using IRS Form 1040-ES.
How is self-employment tax calculated?
Self-employment tax is calculated based on the individual’s net income from self-employment. The tax consists of a combined rate, reflecting the combination of Social Security and Medicare taxes.
Can self-employed individuals deduct any part of the self-employment tax?
Yes, self-employed individuals can deduct the employer-equivalent portion of their self-employment tax when calculating their adjusted gross income.
Related Terms
- FICA (Federal Insurance Contributions Act): A United States federal payroll (or employment) tax imposed on both employees and employers to fund Social Security and Medicare.
- Net Earnings: Gross income from self-employment minus business deductions and expenses.
- Estimated Tax: The method used to pay tax on income that is not subject to withholding, including self-employment income.
Online Resources
Suggested Books for Further Study
- “Tax Savvy for Small Business” by Frederick W. Daily
- “Small Time Operator: How to Start Your Own Business, Keep Your Books, Pay Your Taxes, and Stay Out of Trouble” by Bernard B. Kamoroff C.P.A.
- “J.K. Lasser’s Your Income Tax” by J.K. Lasser Institute
Fundamentals of Self-Employment Tax: Taxation Basics Quiz
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