The Self-Employment Tax
The Self-Employment Tax, which is known officially as the Self-Employment Contributions Act (SECA) Tax, is calculated based on net earnings in order to fund Social Security and Medicare. An employee splits the cost of the tax with their employer, but self-employed individuals are responsible for paying for the full amount.
If you make more than $400 in self-employed income, the IRS requires you to file an income tax return. The tax return must include a Schedule SE to calculate how much self-employment tax is owed.
The 15.3% SECA Tax Includes Two Parts:
1. 12.4% for Social Security – For 2020 tax returns, this applies to the first $137,700 of your earnings. The tax stops at this amount, even if you earn more.
2. 2.9% for Medicare – This tax does not stop, so the self-employed will pay 2.9% of whatever you earn.
Determining the Amount of the SECA Tax Owed
To determine the amount of the SECA Tax that you owe, you can reduce your self-employment income by half of the self-employment tax before applying the tax rate. Yes, you still have to pay the tax, but this reduction will save you money. In addition, the IRS allows the self-employed to claim 50% of what you pay for the SECA Tax as an income tax deduction on Form 1040.
Here’s an example:
$100,000 – Taxable income for a self-employed taxpayer that is reported on Schedule C.
$92,350 – Net earnings reported on Schedule SE ($100,000 multiplied by 92.35% which is the amount of net earnings subject to the SECA Tax.)
$14,130 – Amount owed for the SECA Tax and reported on Form 1040 in the “Other Taxes” section ($92,350 multiplied by 15.3% for SECA Tax.)
$1,170 – Amount “saved” by not applying the 15.3% SECA Tax to the full $100,000.
$1,766.19 – Amount you can save as an income tax deduction (half of $14,130 is $7,065, which is then multiplied by 22% for the tax bracket)
Reporting the SECA Tax
If you start a small business and do not incorporate or form a partnership, the results of the business operations are reported on a Schedule C and filed with Form 1040.
The SECA Tax is calculated on Schedule SE and then reported in the “Other Taxes” section of Form 1040.
Ways to Reduce the Amount of Self-Employment Tax Owed
S Corporation Status – If you create a corporation or limited liability company and make an S Corp election, you can pay yourself a reasonable salary from the earnings. Remaining profits may be subject to income tax, but are not subject to self-employment tax.
Reduce Net Profit – Lower net profit means that less self-employment tax is owed. When completing the Schedule C, net profit can be lowered by deducting every possible business expense. It is important, however, that the business expenses are ordinary and necessary for the business.
Filing Estimated Taxes
Self-employed individuals are responsible for all employment taxes and have full income tax liability, which can be a major burden. There is an opportunity to make quarterly estimated payments throughout the year. This helps avoid a situation where a taxpayer cannot pay their full tax responsibility and then is charged expensive penalties.
Learn More
Click here to learn about optional methods, differences for church employees, or the Additional Medicare Tax.
If you would like more information about the self-employment tax or if you need help calculating the amount you owe, please email me. I am happy to help!