America's income tax system is a progressive tax system, which means that people with higher incomes are taxed at higher rates. Each level of income that corresponds to a certain tax rate is called a bracket. Self-employed people pay the same income tax in certain brackets as everyone else. They're different, however, in that their expenses are treated differently and also in that they have to pay additional taxes.
Self-Employment and Income Taxes
One of the key benefits of being self-employed is that you're able to report your expenses on your Schedule C and subtract them from your business's income. The only thing that ends up on your 1040 is your net profit, meaning that the limitations that can apply to deductions have no effect on your ability to use business expenses. This helps to minimize the effects of ending up in higher brackets, which not only have higher income tax rates but also limitations on your ability to take deductions.
Income Tax Brackets
Although self-employed people calculate their income and expenses differently from the rest of the population, their net income is taxed the same as an employee's salary. As such, they're subject to the six tax brackets that are active in the United States tax code as of January of 2011. These brackets range from a low of 10 percent to a high of 35 percent.
Self-Employment Tax Brackets
In addition to paying income tax, self-employed people are also subject to paying self-employment tax. This tax is the combination of an employee's and an employer's FICA contribution for Social Security and Medicare. The 13.3 percent self-employment tax bracket applies to all self-employment income up to $106,800 per year. Amounts over that amount are only subject to the Medicare portion of the tax, which is 2.9 percent.
Alternative Minimum Tax Brackets
Self-employed people often receive a healthy income as a result of their hard work. Earners of healthy incomes tend to be subject to the Alternative Minimum Tax, or AMT. The IRS calculates the AMT on a taxpayer's income with almost no deductions or exemptions other than a single large, flat exemption. It has two brackets: 26 percent on income up to $175,000 per year, and 28 percent on income above that threshold. Because the AMT taxes net income, though, it applies to a businessperson's bottom-line profit and not his gross sales.
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