What is self-employment tax? (2023-24 rates)

The 2024 self-employment tax rate stands at 15.3%. While this blog is a comprehensive guide to understanding self-employment tax, CoCountant’s tax advisory and filing services can save business owners the precious time and hassle of handling such tedious tax-related tasks.

Picture this: You’ve taken the leap into self-employment, driven by passion and ambition. But amid the excitement, there’s one aspect that demands your attention: self-employment tax.

Don’t let tax complexities discourage your entrepreneurial journey. Let’s decode self-employment tax together so you can begin or continue managing your small business with a clear understanding of self-employment taxes.

With self-employment comes tax responsibility

Transitioning into a self-employed business owner sounds cool and all, but it also brings about the responsibility of self employment tax.

But what exactly is self-employment tax?

Self-employment tax is money that self-employed people pay to the government. It’s like Social Security and Medicare taxes for workers who don’t have an employer to take those taxes out of their paychecks.

This tax, encompassing Social Security and Medicare contributions, mirrors the FICA tax deducted by employers from their employees’ paychecks.

However, unlike traditional employment, self-employed individuals are solely accountable for fulfilling their self-employment tax obligations.

Who needs to pay self-employment tax?

The obligation to pay self-employment taxes arises for every self-employed individual earning $400 or more over the course of the entire tax year. This encompasses freelancers, independent contractors, and proprietors, regardless of whether they are retirees currently receiving Social Security benefits.

Understanding the rates – what is the self-employment tax for 2023-2024?

The self employment tax rate in 2024 stands at 15.3%, comprising 12.4% for Social Security and 2.9% for Medicare.

However, the application of the Social Security portion is limited by the Social Security wage base.

Understanding these rates is crucial for accurate financial planning. The 15.3% rate may seem high, but it’s essential to recognize that self-employed individuals are responsible for both the employer and employee portions of these taxes. While employees typically split the FICA tax with their employers, self-employed individuals bear the full burden.

These rates serve to fund critical social programs, including retirement benefits, disability insurance, and healthcare for seniors. Despite the significant contribution, it’s essential to understand how these taxes impact your financial situation and plan accordingly.

Social Security wage base

In 2022, the Social Security wage base stood at $147,000, escalating to $160,200 in 2023. Consequently, Social Security tax is levied solely on the initial $147,000 of earned income from both wages and self-employment. Conversely, there is no cap on the Medicare segment of self employment tax, implicating that Medicare tax applies to all income from wages and self-employment.

Consider a scenario:

Suppose you have a full-time job earning $100,000 per year. Additionally, you operate a side business that brings in an extra $15,000 annually. Throughout the tax year of 2023, your employer withholds Social Security taxes based on your full-time job income.

Since you’ve exceeded the Social Security wage base, you’re exempt from paying the 12.4% Social Security portion of self employment taxes on your side business earnings. However, you’re still responsible for the 2.9% Medicare portion of self employment tax.

Additional medicare tax

Individuals with higher earnings are required to pay an additional Medicare tax of 0.9% on income exceeding specific thresholds, depending on their filing status:

  • Married filing jointly: $250,000
  • Married filing separately: $125,000
  • All other filing statuses: $200,000

How to calculate self-employment tax

To determine your self-employment tax, begin by identifying your net earnings from self-employment. You can calculate your net earnings for tax purposes by deducting business expenses from business income.

Typically, this involves completing a Schedule C as part of your IRS Form 1040 federal income tax return. Sole proprietors, independent contractors, and other small business owners must include Schedule C in their tax filing.

Fun fact

Did you know that small businesses spend an average of 40 hours per year dealing with federal taxes alone? That’s almost an entire workweek dedicated solely to tax-related tasks!

~ taxfoundation.org

But here’s the silver lining: You can save all those hours in the future by letting CoCountant’s tax advisory and filing services handle these tasks for you.

If your net earnings are below the Social Security wage base, the calculation is straightforward. However, if your earnings surpass this threshold, the calculation involves additional steps.

If your net earnings fall below the Social Security wage base, here’s how to calculate your self-employment tax:

1- Determine your net earnings subject to self-employment tax

Let’s say your net income from self-employment in 2023 is $80,000. To find the taxable amount, multiply $80,000 by 92.35%. This percentage accounts for the 7.65% deduction, considering the employer’s portion of your FICA taxes, which would be withheld if you were an employee.

$80,000 x 0.9235 = $73,880

2- Calculate your self-employment taxes

Next, multiply your self-employment taxable income by the 15.3% self employment tax rate.

$73,880 x 0.153 = $11,294.40

Your self-employment taxes amount to $11,294.40. The result is rounded to the nearest dollar, as the IRS allows rounding off cents to whole dollars on tax returns and schedules.

If your net earnings are above the social security wage base:

1. Figure out your net earnings subject to self-employment tax

Let’s say your net earnings from self-employment were $300,000 for 2023. Only $160,200 of your earnings are subject to Social Security taxes, so we have to add an extra step in the calculation.

  Social Security Medicare
Adjusted earnings $160,200 $300,000
Less: self-employment adjustment (x 92.35%) 0 ($22,950)
Taxable self-employment income $160,200 $277,050

2. Calculate your self-employment taxes.

Next, multiply your taxable self-employment earnings by the individual rates for Social Security (12.4%) and Medicare (2.9%). Furthermore, since income exceeds the Medicare threshold, we have to take into account an Additional Medicare Tax of 0.9%.

  Social Security Medicare
Taxable self-employment income $160,200 $277,050
X Tax Rate(12.40% SS, 2.9% Medicare) $19,865 $8,034
Additional Medicare Tax (0.9% of the amount exceeding $200,000)*   $693
*Assumption all other filling statuses and income exceeding $200,000
Total self-employment tax: $19,865 + $8,034 + $693 = $28,592

When to pay self-employment tax

If your self-employment income reaches $400 or more during the year, you’re obligated to pay self-employment taxes and file Schedule SE with your Form 1040, typically due by April 15th. However, if you anticipate owing $1,000 or more in combined income tax and self-employment taxes, quarterly estimated tax payments are required.

Estimated payment deadlines are typically April 15th, June 15th, September 15th, and January 15th of the following year. These dates shift to the next business day if they fall on a weekend or holiday.

Self-employed individuals can estimate their payments using the worksheet on page 8 of Form 1040-ES. This form assists in calculating the yearly amount owed, dividing it by four, and submitting equal installments by the specified due dates. The form also provides vouchers for mailing payments. If opting for online payment via IRS Direct Pay, vouchers and stamps aren’t necessary.

Is self-employment tax deductible?

Paying self-employment taxes offers a tax deduction for federal income tax filing. You can deduct 50% of your self-employment tax bill from your adjusted gross income, effectively reducing the amount of taxes owed.

For instance, if your self-employment taxes total $2,000, you’re eligible for a $1,000 tax deduction from your taxable income. Depending on your tax bracket, this deduction could save you between $100 and $370 on your tax bill.

How to avoid or reduce self-employment tax

Many new business owners find themselves wary of paying an additional 15.3% in self-employment taxes. The good news is that there are strategies to trim your business tax bill.

1- Track all business expenses

Since self-employment taxes are levied on net earnings rather than gross income, deductible business expenses can significantly decrease your tax liability.

Keep meticulous records and capitalize on all eligible tax deductions and potential credits, including unexpected ones like home office expenses or health insurance premiums.

2- Take an above-the-line deduction

The tax code permits self-employed individuals to deduct half of their total self-employment tax as an above-the-line deduction. This deduction mirrors the employer’s portion of Social Security and Medicare taxes, which would typically be covered by an employer. Simply divide your calculated self-employment tax in half and report it on line 15 of Schedule 1, attached to your Form 1040.

3- Consider an S-corp election

Certain LLC members can alleviate their self-employment tax burden by opting to have their LLC taxed as an S-corporation. This is because S corp owners are only subject to Social Security and Medicare taxes on their salary, while LLC members are liable for self-employment taxes on the entire share of the LLC’s profits.

However, deciding on an S corp election isn’t a one-size-fits-all solution. So, talk to an expert to assess whether this option aligns with your circumstances.

The bottom line

Starting a self-employed business is often a decision born out of big dreams. It usually means leaving behind a job and starting from scratch, with many risks to beware of and many factors to consider. With all that risk and uncertainty, handling taxes should be the least of your worries.

With a financial management service like CoCountant, you can have a dedicated accountant keep your books sorted all year round—not just during tax season—freeing you to focus on your core responsibilities as a self-employed business owner. 

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Disclaimer

CoCountant assumes no responsibility for actions taken in reliance upon the information contained herein. This resource is to be used for informational purposes only and does not constitute legal, business, or tax advice.  Make sure to consult your personal attorney, business advisor, or tax advisor with respect to believing or acting on the information included or referenced in this post.