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What is the Self-Employment Tax?

Self-Employment Tax is the tax towards Social Security and Medicare, required to be paid by a self-employed individual person (i.e. sole proprietors, contractors and freelancers) who has net earnings of $400 or more for the concerned tax period towards the federal government and such tax is reported through the file of Form 1040 Schedule SE.

Self-Employment Tax Rate

The Self-employment tax has two components – Social Security Tax & the Medicare Tax. The basic tax structure is 12.4% for Social Security Tax & 2.9% for Medicare Tax, making it a total of 12.4+2.9= 15.3%

The Social Security tax also has two components – The employer pays social security tax of 6.2% & the employee pays social security tax of 6.2%. Thus, the self-employed person is required to pay for both rates. This makes the total social security tax rate as 12.4%.

The breakup of the self-employment tax is available with the following table:

Rate 1

However, not the whole of net earnings is liable for the 15.3% self-employment tax rate. The first $ 137,700 is liable for social security tax only. Amount beyond $ 137,700 is liable for both social security tax as well as Medicare tax.

However, you are required to pay 0.90% for Additional Medicare in case the total earnings exceed $200,000 (in case of single filer) or exceed $250,000 (in case of joint filer).

Rate 1-1

In case additional Medicare tax is considered, the total Medicare tax becomes 2.9 + 0.9 = 3.8% in some instance. In that the employment tax reaches 15.30+0.90= 16.20%

How to Calculate Self-Employment tax?

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Example #1

Self-Employment Tax Example 1

Solution:

Self-Employment Tax Example 1-1

Example #2

The Taxpayer has provided the following details:

Self-Employment Tax Example 2

Solution:

Self-Employment Tax Example 2-1

Deduction of Self-Employment Tax

IRS has logically framed the self-employment taxation system by allowing the business-related expenses to deducted from the earnings. The tax deductions have been specified as follows:

  • Deduction for home office
  • Deduction for health insurance premiums
  • Meals
  • Travel
  • Interest expense
  • Business Insurance
  • Start-up costs
  • Retirement Plan contributions
  • Rental cost
  • Education
  • Advertising
  • Vehicle use

How to Pay Self-Employment Tax?

If you are sure to earn more than $ 400 a year, you should apply for a social security number (SSN) or taxpayer identification number or an employer identification number. These numbers help the federal government to identify you easily. Then, you would require the following forms.

  • Form 1040-SR to quantify the benefits under social security programs.
  • Form 1040 (Schedule SE) to report your self-employed earnings.
  • Form 1040 (Schedule C) to report the net income or loss
  • Form 8959 to determine the liability for Additional Medicare Tax
  • Form 1040-ES to pay for the estimated tax
  • The payment for the taxes can be made through any of the available methods:
  • The most convenient & reliable method “IRS2Go Mobile Application.”
  • Online payment through the website
  • Wire transfer through a bank account
  • The EFTPS (i.e. Electronic Federal Tax Payments System)
  • Through cash with some additional fee
  • Through check with your details such as name, tax identification number & the year for which tax is being paid.

Benefits

Self-Employment Tax

  • Self-employment tax shows the sensitivity of the person towards the society.
  • It builds the nation with a higher quality of infrastructure.
  • The government can fund the expenses of a needy person through such a collection.
  • The tax rate is also the average and nominal.
  • Computations are easy for a layman with no ambiguities.
  • The individual is helping to build the nation.

Drawbacks

  • Disposable income of the individual decreases.
  • Risk of fraud of public money by the politicians.
  • The tax is a cost for the tax paper. It should have been as per the slab rate system to be more beneficial.
  • Currently, the tax considers every earner on equal grounds which may be correct to assume.

Recommended Articles

This has been a guide to self-employment tax and its definition. Here we discuss example, rate, who should pay and how to calculate self-employment tax along with its deduction and benefits. You may learn more about financing from the following articles –

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