What are Self-Employment Taxes? Self-employment taxes comprise Social Security and Medicare taxes, which are then remitted to federal and state tax authorities. While salaried employees also pay these taxes, there’s a significant distinction. Typically, employers are required to withhold the corresponding Social Security and Medicare taxes from an employee’s wages, whereas self-employed individuals are responsible for paying their own share and the matching amount, or “both halves.” Social Security and Medicare taxes are not considered income tax for self-employed individuals.
Self-employment taxes are based on the net profit of a business (income minus relevant expenses). Of the net profit, 92.35% is subject to self-employment taxes. The self-employment tax rate on net profit is 15.3%, with 12.4% allocated to Social Security tax and 2.9% to Medicare tax.
For the 2023 tax year, the Social Security tax is applicable to the first $160,200 of self-employment income. This is an increase from the $147,000 limit for the 2022 tax year. There is no limit for Medicare self-employment tax on net profit income subject to the 2.9% tax. Additional 0.9% Medicare tax rate may apply to self-employment income if the net income exceeds $200,000 (for single filers) or $250,000 (for married joint filers).
Who is Subject to Self-Employment Taxes? Self-employment taxes apply to individuals whose total net income from self-employment or working for themselves amounts to $400 or more. It’s worth noting that if income from services as a church employee reaches or exceeds $108.28, it is classified as self-employment.
Other individuals considered self-employed for tax purposes include sole proprietors or independent contractors. Jobs typically classified as self-employment for wage earners may include:
Rideshare drivers, Food delivery drivers, Gardeners, Childcare providers, Home care workers, Street vendors, Professional house cleaners, and; Construction contractors.
Self-employment taxes apply to taxpayers of all ages, including those already receiving Social Security or Medicare benefits.
How to Pay Self-Employment Taxes? Federal taxes must be reported and paid to the Internal Revenue Service (IRS). State and local taxes must be reported and paid to the respective state tax authority using either a Social Security Number (SSN) or an Individual Taxpayer Identification Number (ITIN).
Self-employed individuals typically use IRS Schedule C to calculate the net profit from self-employment activities for each tax year. Similarly, the net profit is generally the value of gross income minus appropriate business expenses. Taxpayers can then use Schedule SE to calculate the amount of self-employment tax owed.
If taxpayers use a tax year that isn’t based on the standard calendar year, they must use the tax rates and maximum income limits in effect at the beginning of their tax year, even if rates change after the start of the year, whichever is lower.
When to Pay Self-Employment Taxes? Self-employment taxes must be reported once a year by the applicable tax year’s filing deadline annually. Since self-employed individuals don’t have taxes withheld from “paychecks,” they typically must pay estimated taxes quarterly. Self-employed individuals required to pay estimated taxes quarterly may include:
Those owing at least $1,000 in federal income tax within the year, and Those with income that requires them to pay at least 90% of their current year’s tax obligation, or if their adjusted gross income exceeds $75,000 ($150,000 for married filing jointly), they must pay 100% of the previous year’s tax obligation, whichever is smaller.
Tax Deductions: Despite having to pay self-employment taxes in full or “both halves,” self-employed individuals can enjoy several tax deductions in addition to the benefits of self-employment. If self-employed individuals file their tax return using Form 1040 or 1040-SR with Schedule C attached, they may qualify for the Earned Income Tax Credit (EITC).
Under Section 2042 of the Small Business Jobs Act, self-employed individuals can deduct health insurance premiums. This deduction amount is calculated based on self-employment net income.
Additionally, you can deduct 50% of your self-employment taxes on your federal income tax return. For example, if Schedule SE determines that a taxpayer owes $3,000 in self-employment taxes for the year, they’ll need to pay $1,500 when filing taxes, as the additional $1,500 is considered a tax credit on Form 1040.
Businesses may also be eligible for a Qualified Business Income (QBI) deduction of up to 20%. QBI includes any income, gains, deductions, and losses from trades or businesses. The QBI deduction, also known as the Section 199A deduction, allows taxpayers to deduct up to 20% of business income earned from qualified trades, businesses, dividends, trusts, or estates. The deduction is available regardless of itemized deductions on Schedule A or any standard deduction. Self-employed individuals (if eligible) may also benefit from deductions such as home office expenses, business use of a car, and more.
California: California follows most of the same self-employment tax procedures as the IRS. California also imposes a 15.3% self-employment tax rate. However, California has strict standards when it comes to determining who is classified as self-employed versus an employee of another company. Starting in 2020, California Assembly Bill 5 (AB5) set standards for this crucial determination between employees or independent contractors. In California, drivers focused on transportation or delivery (e.g., Uber or Doordash) may be classified as independent contractors, but this classification remains in limbo as ride-sharing companies and the state of California are in litigation over whether these workers should be classified as 1099 or W2 employees.
California has a broader definition of self-employed individuals and considers most residents who don’t receive checks from business entities as self-employed. This is because half of employment taxes for wage earners are automatically withheld from their checks to fund state and federal programs, while self-employed workers must pay estimated taxes quarterly. In California, you may need to pay self-employment taxes if you:
Work for yourself, Are a sole proprietor or independent contractor, Are a partner in a trade or business partnership, Are a part-time business owner, or Are a member of a limited liability company structured as a partnership.
In California, there’s a Social Security tax assessment cap of $118,500, while Medicare has no income limit. Taxpayers required to pay quarterly taxes must adhere to the following filing dates:
First Quarter Payment – April 18 Second Quarter Payment – June 15 Third Quarter Payment – September 15 Fourth Quarter Payment – January 15 of the following year
Failure to pay self-employment taxes may result in taxpayers facing severe tax penalties. Tax penalties typically start at 5% of the total tax due from the original filing date and increase by that percentage monthly or fraction thereof until the penalty reaches a maximum of 25%.
Potential tax deductions for self-employed individuals in California include health insurance, self-employment taxes, and unreimbursed employee expenses.
