Around 16 million Americans worked for themselves in 2021. That includes freelancers, small business owners, consultants, and individuals with landscaping, cake baking, tutoring, computer repair, or other, similar business. As divergent as these businesses are, one thing they have in common is that they all pay a self-employment tax when it comes time to file their taxes.
What’s the US Self-Employment Tax?
The IRS has set the self-employment tax rate at 15.3 percent for 2022. That rate is the sum of two parts–a 12.4% Social Security tax and a 2.9% Medicare tax. The rationale behind this tax is simple. It’s not a penalty for being in business for yourself, as it might seem at first glance. It’s just an effort to level the playing field between self-employed workers and those who work for someone else.
You see, when you work for a company, that company pays a portion of your Social Security and Medicare taxes. In fact, they pay 6.2% to Social Security and 1.5% to Medicare. The employee pays the same rate for a total of 12.4% and 2.9% respectively. The self-employment tax is just a way for you to get the same funding for these valuable retirement benefits as you would if you worked for a company.
The self-employment tax applies to anyone who has earned more than $400 working for yourself (or more than $108.28 working for a church as an independent contractor or occasional laborer). There’s no age limit on this tax. You pay even if you are already receiving Social Security benefits or if you are unlikely to ever qualify for benefits.
If you work multiple jobs and have FICA deducted from your paycheck, that may be enough to cover your self-employment tax, depending on your total income and what percentage is from your own business.
When Do You Pay the Self Employment Tax?
The US self-employment tax is due when your taxes are incurred. For most self-employed individuals, that means they are due when your estimated quarterly tax payments are due–January 15th, April 15th, July 15th, and October 15th. That’s when you pay 25% of the amount of federal income taxes you expect to owe when you file your tax return. The IRS imposes penalties for underestimating and failing to make estimated tax payments. Estimated tax payments are required of all workers who expect to have a total annual tax obligation of $1,000 or more.
When you file your tax return in April, you’ll need to use IRS Schedule SE to show your work on your self-employment tax calculation.
Calculating Your Self-Employment Tax
The self-employment tax is calculated using your net income. That’s your gross income from your business less your business expenses. (Note: this doesn’t include the standard personal deduction, personal IRA or 401k contributions, and personal charitable deductions.)
You pay self-employment tax on 92.35% of your net earnings. For the 2022 tax year, the Social Security tax applies to your first $147,000 in self-employment earnings. You may also have to pay an additional Medicare tax of 0.9% if you earn more than $200,000 from your business.
How to Minimize the Self-Employment Tax you Pay
While being self-employed brings with it an extra tax, self-employment also offers you the opportunity to deduct many things that someone working for a company cannot. This is perfectly legal and reduces your net income…and therefore your self-employment tax. Just a sampling of the deductions you can take advantage of when you have your own business include…
- Health insurance premiums. This applies as long as you aren’t covered by another work-related policy, such as your spouse’s group health insurance from his job.
- Premiums for long-term disability insurance
- Self-employment tax deduction. Stop shaking your head. You can deduct the portion of your self-employment tax that your employer would have paid had you been working for someone else. This means you pay the tax, but you don’t have to pay taxes on the money you use to pay the tax. Still confused; ask your accountant.
- Home office deduction. If you run your business from your home, you can deduct a portion of all of your home expenses. Generally, the deduction equals the percentage of your expenses equal to the percentage of your home occupied by your home office.
- Meals, lodging, and travel expenses. If you travel more than 50 miles away from your home for business, you can deduct a portion of your travel expenses.
- Mileage. If you use your own vehicle for business, you get a per-mile deduction (62.5 cents in 2022) for every mile you drive to get supplies, deliver products, meet with clients or market your business. All you have to do is keep a log with information on when and how far you drove. Those miles can add up over 12 months.
- Liability or other work-related insurance. Do you have liability insurance for your business (you probably should), errors and omission insurance, or other insurance that’s solely related to your business? If so, then those premiums are deductible.
It’s important to note that you can only use these deductions up to the amount of your total annual gross income from your business.
Obviously, these are only some of the more common tax deductions available to small business owners. Hiring a good accountant with experience in small business tax returns can help you maximize your deductions and pay as little self-employment tax as possible.
To learn more about the self-employment tax and whether it applies to you, contact Eco-Tax at (insert contact info). We’ve been helping small business owners from all 50 states with their tax issues for more than 24 years.