Employees understand how depressing it can be to have their paychecks get reduced due to the money their employers withhold from their paychecks. What's known as FICA withholding for Social Security and Medicare payroll taxes hits employees hard enough that some people might think going out on their own as an independent contractor might be worth it just to keep that money for themselves.
Unfortunately, entrepreneurs and others who work for themselves have to pay taxes of their own. Self-employment tax takes the place of FICA withholding for independent contractors and many business owners who have structured their businesses as pass-through tax entities. Not only are the amounts even higher than what employees see, but you have to be careful to exercise discipline and pay the self-employment tax out of your own pocket. Here are some typical questions and answers about self-employment tax that can help you comply with IRS laws and regulations.
Who has to pay self-employment tax?
The IRS considers you to be self-employed if you carry on a trade or business as a sole proprietor or independent contractor, or if you're a member of a partnership that carries on a trade or business. Part-time businesses do count as self-employment, and entities related to partnerships, such as limited liability companies, can also expose you to self-employment tax.
Self-employed people who make less than $400 from self-employment don't have to pay any tax. Others must file a tax return and pay the tax, even if their total income would otherwise leave them not having to prepare a return at all.
How much are self-employment taxes in 2018?
Self-employment taxes combine the employee and employer portions of the Social Security and Medicare payroll taxes that employers withhold from their employees' pay. The total self-employment tax rate of 15.3% consists of the following:
- 6.2% that would typically get withheld from employee pay for Social Security.
- 1.45% that would typically get withheld from employee pay for Medicare.
- 6.2% for the required employer contribution to Social Security.
- 1.45% for the required employer contribution to Medicare.
In other words, self-employment tax is usually roughly twice what you'd see if you were an employee. As a self-employed person, you're responsible for the employer share of payroll taxes as well as the employee share.
There is a twist you'll want to keep in mind. Self-employment tax gets charged on your business profit, but the IRS lets you count the employer half of the self-employment tax, or 7.65%, as a business deduction for purposes of calculating the tax. That might sound circular, but the net impact is that for a business with profits of $100,000, the 15.3% tax would get imposed not on $100,000 but rather on that amount minus 7.65%, or $92,350.
Is there a maximum self-employment tax?
The tax on Medicare is unlimited, but Social Security taxes have a maximum wage base above which no further tax withholding is required. The wage base limit for 2018 is $128,400, meaning the most you'd pay for the Social Security portion of self-employment tax this year is 12.4% of $128,400, or $15,921.60.
However, total self-employment taxes could be higher than that amount because of the 2.9% that goes toward the Medicare portion. There's no upper limit to what a theoretical maximum self-employment tax could be because of Medicare's lack of a wage base limitation like Social Security has.
When do I have to pay self-employment taxes?
Typically, the IRS requires taxpayers to make estimated quarterly payments in order to cover their self-employment tax obligation. That's because self-employed workers don't have employers to withhold their taxes for them, and it's up to you to make sure you pay your taxes in timely fashion.
Form 1040-ES will help you determine the appropriate amount to pay. It also provides instructions that can help you avoid potential penalties and plan for your tax payments accordingly.
Be smart about self-employment
This calculator is available to help those who work for themselves determine their self-employment tax.For more tax information about self-employment tax, be sure to visit this page on the IRS website. It has helpful information that can tell you whether and how self-employment rules might apply to you.
Nobody likes to see money go to the IRS, but don't fall into the trap of thinking that self-employed people can get out of their tax obligations. As you can see, self-employment taxes are serious business, and the consequences of not paying them in full and on time can be much harsher than what employees ever have to deal with.