Everything You Need to Know About Self-Employment Tax

If you’re an independent contractor, a freelancer, or even a small business owner, then you’re bound to pay self-employment tax.

That’s right—paying taxes is a responsibility that everyone must fulfill, regardless of how much they make.

Do you want to expand your self-employment tax knowledge and ensure you pay the correct tax rates as an independent and disciplined sole trader or freelancer? Then read this article through to the end!

Key Takeaways

• Self-employment tax is imposed on the earnings of self-employed individuals.
• The IRS defines self-employed as sole proprietors, independent contractors, sole members of an LLC, or freelancers.
• The self-employment tax rates for 2023 remain the same, which is 15.3% or a combined 12.4% for Social Security and 2.9% for Medicare.
• The wage base for Social Security is at $160,200, while Medicare taxes have a set of tax thresholds based on the independent contractor’s filing status.
• When filing self-employment taxes, complete your Schedule C (Form 1040), Schedule SE, and 1099-NEC.
• Self-employed taxpayers can deduct their health insurance premiums, startup costs, and home office expenses to help generate higher tax returns and reduce their tax liabilities.

What is Self-Employment Tax?

Self-employment tax is a type of federal income tax imposed on freelancers, independent contractors, and small business owners.

In 1951-1953, the tax rate imposed on self-employed earnings worth $3,600 was as low as 2.25% only. As such, the maximum tax rates were only as low as $81.

One of the main reasons why the tax rates were so low is because Medicare was not yet created at that time, and only the Social Security Tax was imposed by the federal government. In 1960, the Social Security tax rate for independent contractors was only $216.00, $259.20 in 1965, and $538.20 in 1970.

In 1954, the federal government passed the Self-Employed Contributions Act (SECA). It was done to ensure self-employed individuals continue to contribute to funding the government’s social welfare and health programs, namely Medicare and Social Security.

Presently, self-employed individuals cover as high as $24,511.38 in taxes, not including the additional 9% for taxable incomes that exceed $160,200.

Who Pays Self-Employment Tax?

All self-employed individuals or independent contractors pay self-employment taxes. The IRS defines self-employed workers as any of the following:

• You are either an independent contractor or a sole proprietor who runs your own business.
• You run and manage your business by being a part of a partnership.
• You work part-time or earn money through freelancing.

Aside from the conditions described above, there are also specific situations wherein you may be required to pay self-employment tax.

An example of this is when you earn over $108.28 while working in a church. Also, even if you have both a full-time job and a freelancing gig, you will still be mandated to pay self-employment tax if your freelance work lets you earn a net salary of more than $1,000.

Self-Employment Tax Rate for 2023

The tax rates typically get updated every year depending on inflation and the overall status of the economy. Even taxes paid by independent contractors undergo these routine adjustments and changes.

The self-employment tax consists of Social Security and Medicare taxes. In a setup where the taxpayer is hired by a company, they split the federal income tax rates with their employer.

They can expect a distinguishably lower amount of withheld taxes on their net pay. However, freelancers, independent contractors, and sole proprietors cover the combined taxes shared by employers and their employees.

Self-employment tax rates are 15.3% (2.9% for Medicare and 12.4% for Social Security). The wage base for Social Security in 2023 is $160,200. This means if you earn more than $160,200 as a self-employed individual, you are not required to cover your share of Social Security taxes.

In contrast, Medicare does not have a wage base but will impose an additional 0.9% once you reach a particular tax threshold based on your filing status. If you are making more than the thresholds set for your filing status, your new Medicare tax rate will be 3.8%.

The tax thresholds for Medicare are as follows:

How to Calculate Self-Employment Tax

All you have to do to calculate your self-employment tax is multiply your total earnings by 15.3%. Make sure to deduct all expenses before multiplying your earnings by your tax rate.

If you are a single filer earning $160,200, then you will have to pay the 15.3% tax rate for Social Security and Medicare, which is $24,510.60. ($160,200 X 0.153)

That means you are liable for a self-employment tax worth $24,510.60 for the tax year 2023

Now, what if you make $230,000 as a single-filer? In that case, you can:

1. Multiply the first $160,200 of your salary by 15.3%. $160,200 X 0.153 = $24,510.60
2. Multiply the remaining amount from your $230,00 earnings after $160,200. Get the difference between $230,000: $230,000 – $160,200 = $67,800
3. Multiply the difference by 2.9% to account for your Medicare. $67,800 X 0.029 = $1,966.2
4. Subtract $200,000 from $230,000 based on the tax threshold for Medicare tax. $230,000 — $200,000 = $30,000
5. Multiply the result by 3.8%. $30,000 X 0.038 = $1,140.
6. Combine all the results from steps 1, 2, and 3 to yield your total tax liability. $24,510.60 + $1,966.2 + $1,140 = $27,916.8

Ultimately, according to these calculations, you owe $27,916.8 in self-employment taxes for the 2023 tax year.

If your filing status is either Married Filing Jointly or Separately or Head of Household, all you have to do is to check the tax threshold table for Medicare, keep in mind the $160,200 wage base for Social Security, and follow the steps in the example above.

How to Pay Self-Employment Tax

The first thing you must do when paying self-employment tax is prepare your Individual Taxpayer Identification Number (ITIN) or Social Security number.

Then, you must file Schedule C (Form 1040) if you are a sole proprietor or are part of a Limited Liability Company (LLC) to report your business profit or loss.

Next, you will likely be required to fill out Schedule SE (Self-Employment Tax). Schedule SE helps you determine your Medicare and Social Security taxes.

Consequently, your clients should provide a 1099-NEC form to report how much they have paid to your business within the tax year. Similarly, if you have worked with vendors or suppliers to keep your operations well-oiled, then you, as the buyer, will also have to send a 1099-NEC.

Self-Employment Tax Deductions

Paying taxes is twice the financial responsibility for individuals who do not depend on an employer to withhold and share the tax burden for them. On the bright side, you can apply a few tax deductions in your tax returns or use them to reduce your taxes as an independent contractor.

#1. Health Insurance Premiums

Insurance premiums as an independent contractor are more costly. Report your net profits if you want to deduct your health insurance premium expenses from your self-employment tax rates.

Alternatively, you can itemize your insurance premiums as tax deductions on your Form 1040 under Schedule A.

#2. Startup Costs

Starting your own business is no joke. The maximum amount of startup costs you can deduct is $5,000.

Subtracting your expenses in building your startup business is valid for up to 15 years. Startup costs can include the money you had to spend to procure the goods you sell, consultancy, and legal fees you had to seek for your trade.

#3. Home Office

With home office expenses, it is important to use your workstation at home exclusively for your business or freelance work. For example, expenses under “home office” include your PC, laptop, work desk, printer, and utilities like electricity and the internet.

These are expenses that you need to ensure you can operate your business or get started with your freelancing gig even while working within the four corners of your home.

#4. Memberships & Subscriptions

If you sign up for any industry or business-related memberships or use a subscription to digital tools that enable you to conduct detailed research and analysis to hone your business, then you can use your incurred expenses to reduce your tax rates.

Memberships that are designed mainly for leisure or recreational purposes are not considered deductible.

#5. Business Loans

Starting out as a small business owner will inevitably lead you to seek financial assistance from the bank. You can deduct the interest on credit card loans you’ve applied for to cover your business expenses.

When itemizing your credit card interests for your tax deductions, make sure you separate your personal expenses from your business expenses. If you are using a business credit card, keep copies of your monthly billing statements to make it easier to enumerate your tax deductions.

Closing Thoughts

No one is exempt from the responsibility of paying taxes. You may be self-made and successful or have successfully exited the corporate setup by being a sole proprietor or a freelancer.

In the eyes of the IRS, it makes no difference. Fulfilling your tax responsibilities, even as someone who is self-employed, means actively participating in enhancing existing federal programs for social welfare, security, and health.

The key is to keep track of your business or work expenses, check that you pay the correct tax rates, and update your tax forms as needed.