If you are freelancing, own an online store, or otherwise running your own business? Congratulations, you're a part of the millions of Americans who work for themselves.
But now that you're self-employed, you'll find yourself paying a few extra taxes. If your side gig is your only source of income, these "self-employment taxes" can be a bit confusing. They aren't deducted from your paycheck, so you may wonder how to actually pay them.
Luckily, it's not as complicated as your high school math homework was. In this self-employed taxes for dummies guide, we'll review all your self-employed tax obligations. We'll go over who is subject to self-employment taxes and how to pay them.
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What Does "Self-Employed" Mean?
Before we get into the details of self-employment taxes, it's important to understand what it means to be "self-employed" in our context. At its core, being self-employed is simply an umbrella term for people whose work isn't performed on someone else's payroll.
This can mean a lot of things. Some types of side jobs are considered self-employment, while others aren't.
Here are a few examples of activities that could make you self-employed:
Working for yourself: If you’re a freelance writer, graphic designer, or web designer, and work your own hours, then you can consider yourself self-employed, sole proprietor or an independent contractor.
Working for a company that isn't your main job: If you already have a full-time job, but you moonlight by taking on side gigs as a freelancer or consultant, then those off-hours activities are considered self-employment.
Selling goods on eBay or Etsy: If you make good money from selling crafts on Etsy, then you're self-employed and may need to file self-employment taxes.
What Are Self-Employment Taxes?
As a full-time employee, both you and your employee pay FICA taxes (Federal Insurance Contributions Act). FICA consists of two taxes: Social Security and Medicare tax. During the year, the IRS automatically withholds payroll taxes from your paycheck.
The Social Security tax rate for employees is 6.2%, with Medicare tax being 1.45%. Your employer is required to match this combined rate of 7.65%, so they also pay FICA tax.
Self-employment tax applies to self-employed individuals who pay themselves. When you're self-employed, you act as both the employer and employee, meaning you're expected to pay both halves. That's a whopping 15.3% FICA rate for freelancers and independent contractors.
Luckily, though, self-employment tax is deductible. The IRS allows self-employed individuals to deduct the "employer" portion of their self-employment tax, or 7.65 percent (calculated as half of 15.3%) when calculating their income taxes.
That said, generally, whenever the phrase "self-employment tax" is used, it only refers to Social Security and Medicare taxes, rather than any other taxes (like income tax).
Who Has To Pay Self-Employment Taxes?
When thinking about who must pay tax, it's easiest to break it down by income. Like regular income tax, you must file self-employment taxes if your income is over a certain threshold.
Generally, if either of these two circumstances occurs during the year, you must pay self-employment tax:
You qualify if you've earned at least $400 from self-employment over the course of the year. If an entity issued you 1099 for your services, you may be considered self-employed by the IRS.
You made at least $108.28 in earnings from church employment
How to Calculate Self-employment Tax
The amount you pay in self-employment tax is subject to your net earnings. Your net earnings are calculated by deducting your total business expenses from your gross income. You can track your income and expenses with our free ledger template.
Once you've determined your net income, you can apply the 15.3% rate for taxes to determine how much you owe the IRS in self-employment tax.
For example, say you earn $2,000 in side income from your Etsy shop this year. You had business expenses of $800, which means your net earnings are $1,200. Now that you've determined your net earnings for the year, 15.3% of those earnings will be considered self-employment tax and paid to the IRS.
How to Pay Self-employment Tax
Self-employment tax or Social Security and Medicare taxes is paid on Form 1040, Schedule SE. Just like with regular income tax, you'll need to complete this form and submit it with your yearly taxes
If you're due a refund for self-employment tax after filing your return, the IRS will send you a check or deposit any refund amount directly into your checking or savings account. Self-employed people have to file quarterly taxes throughout the year.
If you owe more than $1,000 in self-employment tax after filing a return, you must pay the difference to the IRS by estimated quarterly payments.
You can set up a payment plan by completing Form 9465 and sending it along with your tax return. This must be completed before April 15th of each year. Make sure to save enough for your required quarterly payment so you don't get hit with penalties.
Since the IRS requires quarterly taxes, you'll need to pay any unpaid tax from each quarter by that date.
To avoid penalties or fees for late payment, submit a quarterly payment using Form 1040-ES. You can either mail a check with the form or set up an electronic funds transfer through your bank. If you don't have a checking account, you can also pay by phone or through a debit or credit card.
The worksheet in Form 1040-ES may be used to calculate your estimated tax. You must estimate the amount of money you expect to earn throughout the year. If you predicted your self-employment earnings too highly, complete another Form 1040-ES worksheet to recalculate your estimated tax for the next three months.
If you guessed your income too low, you can get hold of another Form 1040-ES worksheet and recalculate the taxes you likely owe for the next quarter.
If you earned income from September 1st to December 31st, 2021, then your payment is due on January 18th, 2021
If you earned income from January 1st to March 31st, 2022, then your payment is due on April 18th, 2022
If you earned income from April 1st to May 31st, 2022, then your payment is due on June 15th, 2022
If you earned income from June 1st to August 31st, 2022, then your payment is due on September 15th, 2022
If you earned income from September 1st to December 31st, then your payment is due on January 16th, 2023
That said, if you're a U.S. citizen or resident alien and had no tax liability for the previous full tax year, you don't have to make estimated payments to the IRS.
Most accountants recommend self-employed people set aside 30% of their net self-employment income throughout the year in order to pay their Social Security, Medicare and income taxes.
How to Reduce Your Self-employment Tax Bill
The best way to reduce self-employment tax is by lowering your taxable income. You can do this by deducting expenses from your total business income to determine the net profit or loss of the business.
Maximize your contributions on retirement plans to lower your taxable income
Take deductions for business overhead expenses, including any equipment or property you use in the course of your business
Keep track of all business-related purchases to make sure your tax deductions are legitimate
Make donations to charity organizations, as you won't have to pay income tax on the money you contribute
Maximize your Health Savings Account contributions to take full advantage of deductions
That said, here are the deductions you can claim on your Schedule C when you're self-employed (you can use our self-employed deductions worksheet to track your expenses).
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This deduction allows you to claim money you spend on your home office as a business expense. If you use this deduction, make sure you only claim expenses that are related to your self-employment activity. Try our online home office deduction worksheet to track your expenses.
If you pay for online blogs, magazines, or newspapers that are business-related in any way, you can deduct these fees as a business expense.
Business start-up expenses
If you're self-employed, you get to deduct the startup costs for your business from your taxes. These include things like legal and professional services, business structure set up (i.e. limited liability company), advertising expenses (including website design), computer equipment and software, and business cards.
Meals and entertainment
If you go to dinner with a client or hold an event for prospective customers, you can deduct the costs of your meal as long as it's directly related to your business (e.g., spending time discussing work-related matters). Note that meals and entertainment expenses are 50% deductible.
If you have to travel for business, you can claim a deduction for transportation, lodging, and meals.
Almost any office supply can be deducted as a business expense, including pens, pencils, paper, notebooks, stamps, and printing supplies.
Professional fees include any payment you make to accountants or lawyers for tax advice.
If you have a self-employed retirement plan, such as a SEP IRA or SIMPLE IRA, you can deduct your contributions on your taxes.
If you need to take a course as part of your self-employment activity, or if you have to pay tuition for any courses required by your business, you can claim an education expense deduction of those costs from your taxes.
Business insurance premiums
If you take out a business insurance plan, you can deduct those premiums as a business expense.
All advertising costs are deductible, whether you buy print ads, post billboards, or pay for TV commercials.
Health insurance deduction
This deduction allows those who are self-employed to claim health insurance costs as a business expense.
Phone and internet costs
If your phone bill or internet costs are business-related, you can deduct them from your taxes.
A self-employed person can deduct the cost of postage to send out invoices and other work-related documents.
From how these taxes work to how you might be able to reduce the amount of self-employment tax you pay, this guide will help you understand the mechanics behind one of the most confusing parts of being a solo business owner.
Paying self-employment taxes doesn't have to be a pain if you know the process, requirements, and deductions available to you.
We always recommend you reach out to a professional for tax purposes if you have questions about your self-employment tax obligations. An accountant, lawyer or CPA can keep you up to date with the constantly changing tax laws.