What Are Self-Employment Taxes?
Self-employment taxes include both Social Security tax and Medicare tax which are then paid to federal and state taxing agencies. Wage-earning employees also pay these taxes with one major difference. Typically, employers are required to match the amount of social security and Medicare tax withheld from employee paychecks, while self-employed persons are required to pay both their share and the match or “both halves” themselves. Social Security and Medicare taxes are not considered income tax for both wage-earnings and the self-employed.
Self-employment tax is based upon the net profit, income less applicable expenses, of the business. Of that net profit, 92.35% is subject to self-employment tax. The Self-employment tax rate on net profit is 15.3%, of which 12.4% is attributed to social security tax and 2.9% to Medicare tax.
For the 2023 tax year, the first $160,200 of self-employed earnings are subject to the 12.4% social security tax. This is an increase from the $147,000 limit for the 2022 tax year. There is no limit on the net profit earnings subject to the 2.9% Medicare self-employment tax. An additional 0.9% Medicare tax rate may apply to self-employment earnings if net earnings exceed $200,000 for single filers or $250,000 for those who are married filing jointly.
Self-employment tax applies to people who either work for themselves or whose net earnings from self-employment total $400 or more. Please know, church employees are classified as self-employed if they earn $108.28 or more.
Other people considered self-employed for tax purposes are sole proprietors or independent contractors. Jobs where wage earners are commonly classified as self-employed may include:
- Drivers for ride sharing companies,
- Drivers for food delivery companies,
- Childcare workers,
- Homecare workers,
- Street vendors,
- Professional house cleaners, and;
- Construction contractors.
Self-employment tax applies to taxpayers of all ages, including those already receiving Social Security or Medicare benefits.
Federal taxes must be filed and paid to the Internal Revenue Service (IRS). State and local taxes must be reported and paid to your appropriate state taxing authority using either a Social Security Number (SSN) or Individual Taxpayer Identification Number (ITIN).
Self-employed individuals typically use IRS Schedule C to calculate net profits from self-employment activities for each tax year. Again, net profits are typically the value of gross earnings less appropriate business expenses. Taxpayers may then use Schedule SE to calculate the amount of self-employment tax owed.
If a taxpayer is using a tax year not based on the standard calendar year, they are required to use the rate and maximum earnings limit in effect at the beginning of their tax year, even if the rate changed after the beginning of the year, to calculate their self-employment taxes.
Self-employment tax must be filed annually in accordance with the filing deadline for each applicable tax year. As self-employed persons do not have taxes withheld from a “paycheck,’ they typically must make quarterly estimated tax payments. Self-employed individuals required to make quarterly estimated tax payments may include:
- Those who owe at least $1,000 in federal income taxes in a year, and
- Those with applicable earning must remit an amount that is equal to at least 90% of tax liability for the current year or 100% of the previous year’s tax liability if their adjusted gross income was more than $75,000 for individuals ($150,000 for married couple filing jointly), whichever number is smaller.
Even though self-employed persons must pay the full amount, or “both halves” of self-employment taxes, in addition to the benefits of being self-employed, there are a number of tax deductions available to the self-employed. Self-employed individuals may qualify for the Earned Income Tax Credit (EITC) if filing a tax return Form 1040 or 1040-SR with a Schedule C.
Self-employed individuals, under Section 2042 of the Small Business Jobs Act, are allowed to deduct their cost of health insurance. This deduction is calculated based on net earnings from self-employment.
Additionally, 50% of self-employment tax can be deducted on your federal income tax return. For example, if Schedule SE states a taxpayer owes $3,000 in self-employment tax for the year, they need to pay $1,500 when taxes are due as the other $1,500 would be considered a tax credit on their Form 1040 return.
Businesses may also receive qualified business income (QBI) deductions of up to 20%. QBI includes any income, gain, deduction, and loss from trades or business. QBI deduction, also known as Section 199A tax deduction allows taxpayers to deduct up to 20% of their business income from their self-employed taxes earned from qualified trades, dividends, trusts, or estates with passthrough business income. The deduction is available regardless of itemize deductions on Schedule A or any taken standard deductions. Self-employed business owners, as applicable, may also receive deductions for a home office, business use of an automobile, and more.
The state of California follows most of the same self-employment tax procedures as the IRS. The state of California assesses the same 15.3% self-employment tax rate. However, California has strict criteria when considering who is classified as self-employed versus an employee of another company. Beginning in 2020, California Assembly Bill 5 (AB5) sets the criteria in this key determination between an employee or independent contractor. In California, drivers for applications focused on transportation or deliveries such as Uber or Doordash may be considered independent contractors, but this classification is still pending as there is ongoing litigation between rideshare companies and California over whether these workers should be classified as 1099 or W2 employees.
California has a broader definition of what it means to be self-employed and considers most residents who do not receive a check from a business entity as self-employed. This is because employed workers have half of their employment taxes automatically deducted from their checks to fund state and federal programs whereas self-employed workers must make quarterly estimated tax payments. In the state of California, you must pay self-employment tax if you are:
- In business for yourself,
- Working as a sole proprietor or independent contractor,
- A partner of a partnership that carries on a trade or business,
- Part-time business owner, or
- A member of a limited liability company which is structured as a partnership.
In California, Social Security tax is assessed up to a limit of $118,500, while Medicare does not have an earning limit. Filing dates for those required to make quarterly tax estimated payments are:
- First Quarter Payment – April 18th
- Second Quarter Payment – June 15th
- Third Quarter Payment – September 15th
- Fourth Quarter Payment – January 15th of the following year
Failure to pay your self-employment taxes may result in a taxpayer facing severe tax penalties. Tax penalties typically start at 5% of the total tax due on the original filing date. This percentage is usually increased every month or every partial month until the penalty reaches a maximum of 25%.
Potential tax deductions in California for self-employed individuals include health insurance, self-employed tax, and unreimbursed employee expenses.
RJS LAW and its qualified, experienced tax attorneys are available to help on all tax-related issues. Please contact us at 619-595-1655 or via the website for a free consultation.
Written by Judith Jeremie