Self-employed workers can take advantage of numerous tax breaks available to business owners, but that flexibility comes at the cost of owing self-employment tax. Whereas employees only pay the employee share of payroll taxes for Social Security and Medicare, self-employed workers have to pay the employer half as well, boosting the maximum tax rate to 15.3%.
Although a wage limit of $137,700 applies to the Social Security portion of self-employment taxes in 2020, the 2.9% Medicare portion is unlimited. In addition, an additional 0.9% Medicare tax can also apply for high-income taxpayers. That can make it tough to figure out how much you'll owe, but this self-employment tax calculator can do the heavy lifting for you. Let's look more closely at self-employment taxes and how this calculator can help you.
How self-employment taxes work
Self-employment taxes are designed to make sure that the federal government gets the full amount of payroll taxes it's owed. For regular workers, your employer withholds money for Social Security and Medicare tax from your paycheck at the rate of 7.65%, and it pays a matching 7.65% from its own money for its share of payroll taxes. But since self-employed people don't have employers, you have to pay the entire 15.3% amount from your profits, which are defined as your net earnings less the employer portion of self-employment taxes.
The full 15.3% tax only applies up to the wage base limit for Social Security, which is $137,700 in 2020. Above that level, only the 2.9% self-employment Medicare tax applies. However, there's also a 0.9% Medicare surtax for single filers with income over $200,000 or joint filers above $250,000.
Also, some people have income from traditional employment and self-employment income. In that case, your regular employment income counts first against the wage limit above, since you and your employer have already paid payroll taxes on that amount. Self-employment taxes will still apply to your income from that source, but they can be less depending on how much your respective earnings were.
An example of calculating self-employment tax
The calculator for calculating self-employment tax is deceptively simple. Just put in your self-employment income, any income you earn from regular employment, and your filing status. The calculator does the rest.
Let's take two examples. In the simplest one, say you make $30,000 from self-employment income and have no other work. The calculator takes your gross income and then reduces it by 7.65%, coming up with taxable self-employment earnings of $27,705. It then takes 15.3% of that amount, which works out to $4,239. You're allowed to deduct half that, or $2,119, against your income tax liability.
A more complex example shows how regular work and self-employment coordinate. Say you still make $30,000 from self-employment, but you also earn $150,000 from your regular day job. For the Social Security portion of self-employment taxes, the $150,000 in regular job income counts against the $137,700 limit, leaving you with no self-employment tax for the Social Security portion. However, the taxable self-employment earnings of $27,705 are still subject to Medicare taxes, working out to self-employment tax of $803 and a $402 deduction against your income tax liability.
Don't pay more than you have to
Also, bear in mind that the self-employment tax is charged against net income from your self-employment. If you have deductible expenses that you can take against the revenue you bring in from your business, then they will reduce the amount of income for purposes of calculating the self-employment tax. That makes it all the more valuable to take whatever deductions you're entitled to use in your self-employment activities.
That said, if you do owe substantial self-employment tax, remember to make estimated tax payments on a quarterly basis. Otherwise, the IRS can hit you with penalties on your annual tax return if you didn't pay as much as you were supposed to throughout the year.
Self-employment tax can be a big burden, and the tax bill can be larger than you expect. By knowing what the amount is beforehand, you can plan for self-employment tax and avoid any nasty surprises at tax time.