A Self Employment Tax Overview with Example Calculations
Self-employment tax is what freelancers and small business owners pay. It is made up of social security and Medicare taxes, just like employed people pay from their earnings. The self-employment tax rate at this time is 15.3 percent of your net income, which breaks down into 12.4 percent for social security and 2.9 percent for Medicare. This is for earnings up to $160,200 as of 2023.
Earnings over the $160,200 mark are not subject to the social security portion of the taxes but are still subject to the Medicare tax. If your net earnings surpass $200,000 as a single filer or $250,000 for joint filers, you can expect to pay an additional 0.9 percent on Medicare taxes.
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Who Needs to Pay Self Employment Tax?
The term “self-employed” covers a wide range of work. Most of it falls under the titles of freelancer, small business owner, or independent contractors. However, before we move on, let’s cover the independent contractor category.
There are many types of work that fall under this category, and not all of them are done by the self-employed. For instance, many of the restaurants that I have worked for consider their servers to be independent contractors, but we still received W2s each year. The point is that this category can be misrepresented or misunderstood.
If you receive a W2, meaning that you work for someone who withheld taxes on you, self-employed is not the term to use. For those who have jobs that seem to be in a gray area, you can ask a tax professional for clarification.
Now that we have that out of the way, let’s get back to the regularly scheduled programming. So, again, if you are a freelancer, small business owner, or an actual independent contractor, you will need to pay self employment tax if you meet either of the following criteria:
You are employed by a church and received at least $108.28 of income.
Your net earnings from your self-employment are $400 or more- minus any income from a church.
How the Self Employment Tax is Calculated
A moment ago we talked about the rate for the self-employment tax, but not how it is calculated. The self-employment tax is applied to 92.35 percent of your net earnings, and your net earnings are determined by deducting your business expenses from your gross income.
You can use IRS Schedule C to help you calculate your net earnings, but we are going to go through a quick overview here. For the sake of simplicity- something I love- we are going to say that your gross earnings for the year are $100,000. Now, let’s dive in and determine what your net earnings would be.
Self Employment Tax Deductions
As stated above, your net earnings are your business expenses subtracted from your gross income. While there are many business expenses that can be deducted, below are some of the most common ones- and they are ones we are going to imagine your business has.
Home Office
When you work from home, your home office can be a tax deduction. However, this is a deduction that you have to be careful with. Let’s start with the fact that you can deduct mortgage interest, property taxes, utilities, insurance, maintenance, and even depreciation.
The key is that you can only deduct a portion of each of these categories- just the percentage that is used for your home office. You could play the guessing game, but guessing is not the best move with the self-employment tax- you do not want to be audited and only have guesstimates to share.
Instead, some experts suggest creating a diagram of your home. It does not have to be anything fancy. You can just make a simple floor plan with lines for walls. There is no real need to add all of your furniture unless you just want to. Label each room and highlight your home office.
Take it one step farther for extra protection in case of an audit. Actually, measure each of your rooms and determine the actual percentage of your home that is the office. If the size is 20 percent of the house, you can deduct 20 percent of all of the categories mentioned above. In the case of your business, let’s say that 20 percent of those costs would be $2,000, so our calculations start with:
$100,000 - $2,000= $98,000
Office Supplies and Equipment
Any supplies and equipment you purchase and maintain for your business can add to your deductions. For instance, if you have a laptop, printer, and fax machine that you use strictly for business, those costs can be deducted. So can supplies such as printer paper, staplers, pens, and so on. If you purchase it and use it for your business, you should have no trouble deducting it. Just be sure to keep up with receipts for proof- just in case. For our example, let’s use the following:
$1,000- Laptop
300- Printer/Fax Machine
200- Printer Paper
1,500- Desk/Filing Cabinet/ Phone/ Chair
500- Pens/Notepads/Staples
$3,500
Of course, these costs will vary depending on the type of business you run, but again, we are keeping it simple. So:
$98,000 – 3,500= $94,500
Health Insurance
If you do not qualify for any other health plan, such as your spouse’s employer's health plan, and you pay for your own health insurance, you can deduct the cost of your premiums. Your premiums add up to $1,200:
$94,500 – 1,200= $93,300
Business Insurance
If you pay for any type of business insurance, you can deduct that as well. Some common business insurances include business liability, business vehicle insurance, and fire insurance. There are several other types that you might be considering. Whatever you choose, if they are for your business, they should be easily deducted from your business tax. For our example, yours is $2,000 per year:
$93,300 – 2,000= $91,300
Internet/Phones
Any internet or phone usage used strictly for your business can also be deducted. Having a separate phone for business than you do personal use can simplify this. You might also talk to your internet provider to see if they can set up business internet separate from your home internet. If you can separate these two bills on paper, you will easily be able to determine how much you can deduct.
If that is not possible, you will need to determine how much of each you use just for your business. This does not have to be difficult. If you spend a total of 16 hours per day on the internet and eight of those hours are business hours, you can deduct half of your bill. It can be helpful to jot down how much time you spend on your phone and internet for business each day for a month or so. This can give you a pretty accurate measure of your deduction. Your costs are $3,000 for the year:
$91,300 – 3,000= $88,300
Education
If you choose to take classes to improve the skills you need for your current line of work, you can deduct those. However, they have to be for the business you already have. If you are looking into education for a new business, you cannot deduct that.
We’ll say that you took a couple of digital marketing courses for your digital business that came to $500:
$88,300 – 500= $87,800
Travel Costs
Some businesses require travel. Whether you are driving, flying, or getting around some other way, you can deduct those costs. This travel deduction has stipulations, though: It must require you to stay away from home at least overnight and business has to actually be conducted in that location.
Keep receipts and- at a minimum- notes about the business you conducted, just in case the IRS gets curious. They tend to pay attention to travel deductions, especially when a business has more than the average business. This is because you can deduct 100 percent of your travel expenses, as long as they are not unnecessarily extravagant. As far as food while you travel goes, it too can be deducted but only 50 percent of it.
For our example, the costs you can deduct come to $2,000:
$87,800 – 2,000= $85,800
Retirement Plans
Just as contributions to retirement accounts are typically tax deductible for those employed by others, it is the same for contributions that the self-employed make. Take advantage of this as often as you can. For now, we will say you have $1,000 in contributions that can be deducted:
$85,800 – 1,000= $84,800
Advertising
Any advertising you pay for to drum up business or even to raise money for charity can also be deducted. This is especially excellent for those that spend a lot on advertisement in the beginning to build the business up. Your advertising costs came to $1,800 for the year:
$84,800 – 1,800= $83,000
Your net income is $83,000. How much of that can be taxed?
$83,000 x 92.35 percent= $76,650.50
This means that $76,650.50 is taxable. So, how much will those taxes come to? Let’s take a look:
As your net income is below the $137,700 threshold, all of your net earnings are subject to both the Social Security tax and the Medicare tax. However, since you did not surpass that $200,000 of net earnings as a single filer or $250,000 as a joint filer, the additional Medicare tax does not apply to you.
More on Self Employment Tax Deductions
There tends to be confusion surrounding the self-employment tax, especially in the beginning. I remember being told that I would not qualify for the Child Tax Credit or the Earned Income Tax Credit (EITC). These words came from someone who had never been self-employed, but I really had no clue what to expect.
Well, it turns out this person- and some others- was completely wrong. Being self-employed does not immediately disqualify you from any credits. You are only disqualified if you do not meet the criteria- none of which I have found requires that you be employed by someone else. Unless an actual tax professional tells you that you do not qualify, ignore it.
How Exactly Do You File Your Self Employment Tax?
First off, you will want to use the IRS Schedule C that we talked about a moment ago. This will help you calculate your net earnings. You will then need to use IRS Schedule SE to calculate your actual self-employment tax owed. To file, you will need either your social security number or an individual taxpayer identification number (ITIN).
There are several ways that you can physically file your taxes. Software from tax services like Tax Act, H&R Block, Turbo Tax, and others have gotten me through several years. You can also file on the IRS website. Many county courthouses will file your taxes for free, too.
Should I Hire a Professional?
Of course, you can always hire a professional tax service to handle your taxes for you. Do remember, though, that many services charge more than anyone wants to pay. Before you choose a service to handle yours, be sure you ask for prices and check reviews because they are not always upfront with their pricing. This does not apply to all of them, of course, but you should always know what you are signing up for.
Consider Filing Quarterly
There is another important point to make about filing. When you are employed by someone else, you usually only file once a year. While you can do this if you are self-employed, there may be consequences- mostly in the name of late fees. You should make quarterly payments instead to prevent these fees or any other issues.
As an added note, I remember reading from a freelancer that she just automatically puts up 30 percent of her earnings for taxes. She does not always have to pay out that much- in fact, she has not up to the point when I was reading- but this was her way of playing it safe. When she needed to make her quarterly payments, the money was already available. She did not have to worry about late fees or about scrambling to find the money. It was already there.
In my opinion, especially since many self-employed people qualify for good credits that minimize their tax liability- or even get them a refund- 30 percent might be a bit high. You might choose to imitate her habit exactly, which is not a bad move at all. You might also choose a lower percentage to put away. Either way, socking money away for taxes is never a bad idea.
Filing Yourself vs Hiring a Pro
I have been doing my own taxes since I turned 20, but it was always when I worked for someone else. Filing W2s is pretty simple, especially after you have done it once or twice. Filing as a self-employed person? I have to admit that I was very nervous. I was terrified that I would mess something up and get audited. What if I forgot to keep receipts or put in the wrong amount on a deduction? What if I completely messed them up?
I took a deep breath and did it anyway, and it really was not any more difficult than filing the W2s. The point is that you can do it on your own. However, if you have never filed taxes at all before or you just cannot get up the courage to try it on your own, there is nothing wrong with hiring tax preparation services.
Hire them every time you file if you want, or just hire them the first time. After you take a look at your tax return, you can get an idea of how to file for the next time. If you need to hire someone else to do it, use it as a learning experience. It probably will not take long for you to feel comfortable enough to do it yourself.
Conclusion
Taxes, in general, can get complicated. Learning how to manage your taxes as a self-employed person can be even more difficult, but it is not impossible. Hopefully, this guide has given you the information you need to get a good grasp of the self-employment tax.
If you are still uncomfortable, or just do not want to deal with it, consider hiring a bookkeeper or accountant to help keep up with it for you. One excellent quality needed to run your own business is knowing what your strengths and weaknesses are, and knowing when to delegate.