The self-employment tax is the equivalent of the FICA taxes that are imposed on employee income, except the rates appear twice as high. The IRS takes the position that you're both employer and employee when you work for yourself. Normally, your employer would pay half of these taxes and you would pay the other half, but you must pay both the employer and the employee portions if you're self-employed.
You’re responsible for paying not only income taxes on your earnings, but the self-employment tax as well if you have net self-employment income of $400 or more. Net income is what remains after you subtract your ordinary and necessary business expenses.
Read More: What Are Self-Employed Taxes?
The Contribution and Benefit Base
The self-employment tax is comprised of two taxes: the Social Security tax of 12.4 percent and the Medicare tax of 2.9 percent, for a total of 15.3 percent. The Medicare portion of the self-employment tax applies to all your self-employment income. But the Social Security portion applies only to self-employment income up to the annual contribution and benefit base for the year. Any self-employment income in excess of the contribution and benefit base is exempt from the Social Security portion of the self-employment tax.
This base is $147,700 in 2022, up from $142,800 in 2021 because it's adjusted annually for inflation. You'd use the 2021 figure to calculate the tax you owe on the return you'd file for the 2021 tax year in 2022. You won’t have to pay the Social Security portion of the tax on earned income in excess of $142,800.
Read More: When Can I Stop Paying Social Security Tax?
Self-Employment Tax Formula
You must first calculate your net self-employment income to figure out how much self-employment tax you'll owe. Subtract your deductible business expenses from your gross receipts on Schedule C. You can then calculate your self-employment tax using Schedule SE when you've determined your net self-employment income.
First calculate your self-employment income subject to the self-employment tax by multiplying your total Schedule C income by 0.9235 if your earnings don't exceed the contribution and benefit base of $142,800 for the 2021 tax year. Only 92.35 percent of self-employment earnings are subject to these taxes. Then multiply the result by 0.124, the Social Security tax rate. Multiply it by 0.029, the Medicare tax rate. Add the two together to arrive at your self-employment tax.
Let's say you had a $100,000 salaried job in 2021 and your net self-employment income for the year was $40,000 when the contribution and benefit base was $142,800. This gives you a total income of $140,000. You would owe Social Security tax on your entire net self-employment income because $140,000 doesn't reach the benefit base of $142,800. Only the portion of your earnings above $142,800 would be exempt from the Social Security tax for the year.
Now multiply your $40,000 in net self-employment earnings by 0.9235 to get $36,940. You can forget your $100,000 in salary because presumably FICA taxes have already been withheld from those earnings by your employer.
Multiply $36,940 by 0.124 to find that you’ll owe $4,580 for the Social Security portion. Next, multiply $36,940 by 0.029 to find you’ll owe $1,071 for the Medicare portion. Add $4,580 and $1,205 to find your total self-employment tax of $5,651.
Instructions for the calculation process are clearly outlined, step by step, in IRS Schedule SE.
Reduce Your SE Tax
You pay self-employment tax on your net business income, so taking advantage of as many business deductions as possible will reduce your business income and save you some money on taxes. Self-employed individuals can deduct expenses for advertising, utility bills, travel, home office use, depreciation, office supplies, training and insurance premiums from their gross business income to arrive at a lower net income that will be subject to tax. You can claim any of these expenses you qualify for when you complete Schedule C.
The IRS rule is that your deductible expenses must be "ordinary and necessary." Ordinary means that most people in your field spend money on the same expenses. An expense is considered necessary if it's helpful and appropriate in your line of work.
Read More: Self-Employed Tax Deductions, Benefits & More
You can also take advantage of up to a $5,000 deduction for your business's start-up costs if your business has just gotten off the ground. You might also be able to claim the qualified business income deduction that's been available since tax year 2018. This deduction allows you to deduct up to 20 percent of your business income if you qualify.
- IRS: Topic Number 554 - Self-Employment Tax
- Social Security Administration: Contribution and Benefit Base
- Social Security Administration: FICA and SECA Tax Rates
- Intuit QuickBooks: Complete List of Self-Employed Expenses and Tax Deductions
- Social Security Administration: If You Are Self-Employed
- IRS: Retirement Plans for Self-Employed People
- IRS: Publication 535 (2020), Business Expenses
- IRS: Qualified Business Income Deduction
- If you owe the self-employment tax, the IRS has traditionally allowed you to deduct half the amount from your income taxes, representing the equivalent of the employer portion of FICA taxes. However, in 2011, the employee portion of Social Security tax equals 6.2 percent while the employee portion equals 4.2 percent, so the IRS may allow you to deduct the employer portion rather than splitting it in half because the employee and employer portions are no longer equal.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."