Self-employment tax is a tax that self-employed individuals are required to pay to fund Social Security and Medicare, which are collectively referred to as the Federal Insurance Contributions Act (FICA) taxes. Self-employed individuals, including freelancers, sole proprietors, and independent contractors, are responsible for paying these taxes because they don’t have an employer to withhold them from their paychecks, as is the case with traditional employees.
The self-employment tax rate is typically higher than the Social Security and Medicare tax rates paid by employees, but self-employed individuals are allowed to deduct the employer-equivalent portion of these taxes as a business expense when calculating their net income for income tax purposes.
Here’s a breakdown of the components of self-employment tax:
- Social Security: This portion of the tax is used to fund retirement, disability, and survivor benefits. As of my last knowledge update in September 2021, the Social Security tax rate for self-employed individuals is 12.4% on net earnings up to a certain income threshold (the “taxable earnings base”). For income above this threshold, there is no Social Security tax.
- Medicare: The Medicare portion of self-employment tax helps cover medical expenses for individuals age 65 and older. The Medicare tax rate for self-employed individuals is 2.9% on all net earnings, with no income limit.
- Additional Medicare Tax: For high-earning self-employed individuals, there is an additional Medicare tax of 0.9% on earnings exceeding a certain threshold (as of 2021, $200,000 for single filers and $250,000 for married couples filing jointly). This tax is in addition to the regular 2.9% Medicare tax.
- Net Earnings: Self-employment tax is calculated based on your net earnings from self-employment activities. Net earnings are generally your total self-employment income minus allowable deductions, such as business expenses.
- Deduction for Employer-Equivalent Portion: Self-employed individuals can deduct the employer-equivalent portion of their self-employment taxes when calculating their adjusted gross income for federal income tax purposes. This deduction helps offset the impact of paying both the employer and employee portions of Social Security and Medicare taxes.
It’s important for self-employed individuals to understand their tax obligations and make estimated tax payments throughout the year to cover their self-employment tax liability, as well as any income tax liability. Failure to do so may result in penalties and interest.
Since tax laws and rates can change over time, I recommend consulting with a tax professional or checking the most current tax information from the Internal Revenue Service (IRS) to determine your specific self-employment tax obligations and deductions based on your income and circumstances.
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