The Self-Employment Tax

If you are self-employed, you must pay the Self-Employment tax, or “SE tax”. The SE tax covers Social Security and Medicare for self-employed people.

This article defines the self-employment tax and how it is determined, and tells you how to report the tax on your income tax return. There is also a brief introduction to paying estimated taxes.

Many newly self-employed people are surprised at their tax bills at the end of the year because they notice that they paid a lot more tax as a self-employed person than they did as an employee. That’s because as a self-employed person, you pay two types of income taxes: the self-employment tax, and the regular income tax. If a company previously employed you, the company paid half of the self-employment tax, which covers your liability for Social Security and Medicare benefits.

The self-employment tax is based solely on the business income that you report on Schedule C. It is 15.3% of your net earnings from self-employment as reported on Schedule SE. The tax consists of two portions:

Income tax is applied to the total income as reported on your tax return. We’ve seen situations where taxpayers had Schedule D losses that more than offset their Schedule C income, reducing or eliminating their total income, but they still owed SE tax with the return. While you can sometimes reduce or eliminate your income tax liability, if a Schedule C shows income after expenses, you will pay the SE tax.

For more information on this tax, see IRS Tax Topic 554: The Self-Employment Tax and IRS Publication 533: Self-Employment Tax.

When you start a small business and you do not incorporate or form a partnership, you report the results of your operations on Schedule C of Form 1040 You report your gross revenue, and detail your expenses. The result of netting your revenues and expenses is a net profit or loss. (Article 7) and IRS Publication 334: Tax Guide for Small Business.

You calculate your self-employment tax on Schedule SE. You report the total tax calculated on Schedule SE in the “Other Taxes” section of Form 1040. In this way, the IRS differentiates the SE tax from the income tax. Good news: you can take one half of your self-employment tax amount as a deduction against total income on line 29 of Form 1040.

Assume after all expenses are recorded, your Schedule C business earns $35,000. Net earnings as calculated on Form SE would be $32,323 ($35,000 x .9235). Your self-employment tax would be $4,945 (32,323 x .153) and would be reported on Form 1040, line 56, in the other taxes section. Then one half of the self-employment tax, $2,473, ($4,945 X .50) is reported on Form 1040, line 29 as an adjustment to income, which reduces the income tax that is applied to your self-employment net income reported on Form 1040, line 12.

If you have worked as an employee, you know that the net earnings on your paycheck are much less than your gross earnings. Why? Because your employer withheld money for Social Security, Medicare, and income tax, and sent that money to the government.

When you are self-employed, the entire burden for paying employment taxes and prepaying estimated income tax liability is left to you. That’s why you need to pay estimated taxes in quarterly installments to the U.S. Treasury; otherwise, you may be subject to underpayment penalties.

If you’re not sure whether you meet the definition of being self-employed, see IRS Tax Topic 554: The Self-Employment Tax and IRS Publication 533: Self-Employment Tax.. You can also use TurboTax or ask your tax preparer to help you determine how much to pay in estimated taxes to cover your self-employment tax and future tax liability.

For more information on estimated taxes, see IRS Tax Topic 355: Estimated Tax.

Related Articles:
Self Employed Factsheet
Self Employment Tax
Tax Filing Requirements
Tax Filing Errors