While many employees are finishing up filing W-2s or 1099 forms for taxes, some may find themselves in a unique situation - that is, being self-employed.
Whether you have your own business, are an independent contractor or work as a freelancer in a variety of vocations, you will have to do your taxes a bit differently - namely, filing a self-employment tax. Officially called the SECA tax for the Self-Employment Contributions Act tax, self-employment taxes are a bit different from regular W-2 forms or ordinary employee forms.
What actually is the self-employment tax, and how does it work? Better still, what kinds of deductions can you take from the self-employment tax?
What Is the Self-Employment Tax?
The self-employment tax (SE tax) is a tax for individuals who are self-employed and accounts for Social Security and Medicaid. Individuals qualifying for the self-employment tax include those who own businesses, are contractors or freelancers, and must file SE taxes for themselves using the 1040 form Schedule SE through the IRS.
Akin to the Federal Insurance Contributions Act (FICA) tax that employees and employers have to pay, SE tax is a mixture of Social Security and Medicaid and is due every year on your net earnings (or, in some cases, on a quarterly basis based on estimated taxes).
Typically, the tax burden of paying for both Social Security and Medicaid falls on the employer for 6.2% of the tax, and the employee for the remaining 6.2% of the tax for Social Security (and another 1.45% apiece for Medicaid). However, without a designated employer to pay the other portion of the tax, a person qualifying as self-employed will pay the entire tax - or, 12.4%. So, because you are no longer sharing the tax burden of paying for Social Security and Medicaid with an employer, self-employment tax can tend to be higher because the burden falls solely on your shoulders.
Some self-employed taxpayers like partners, sole proprietors or "S" corporation shareholders must file quarterly estimated taxes - mainly when they anticipate paying more than $1,000 in taxes for the year (sometimes even $500 for some corporations).
But, what is the current rate of self-employment tax?
Self-Employment Tax Rate
According to the Internal Revenue Service (IRS), the self-employment tax rate is 12.4% for Social Security and 2.9% for Medicare. And the self-employment tax rate is 12.4% for Social Security on the first $132,900 of net income or earnings (anything above that amount is not taxed), plus an additional 2.9% on the net earnings for Medicaid tax. The combined tax is 15.3%.
The maximum tax for $132,900 would be $16,479.60 for the 12.4% Social Security tax plus 2.9% for Medicaid.
But, who is subject to self-employment tax?
Are You Subject to Self-Employment Tax?
The answer might not be as obvious.
If you own your own business, you qualify for self-employment tax. Additionally, if you are an independent contractor, sole proprietor, or working as a freelancer in some capacity, you will also need to file a self-employment tax.
According to the IRS, you are considered self-employed if you:
- Are an independent contractor or sole proprietor of a business
- Are part of a partnership of a business or trade
- You are in what the IRS calls "other business" in some capacity or part-time
- Made $400 or more in net earnings from self-employment, or $108.28 or more for church employee income
Additionally, for spouses or joint-ventures, the IRS claims that for "purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for Federal income tax purposes under the provision."
So, basically, if you are a partner, sole proprietor, owner, freelancer, independent contractor or some variation of those, you qualify as self-employed and will be subject to self-employment tax. But, how are those taxes broken up?
Where Do Your Self-Employment Taxes Go?
Given that you, as a self-employed person, do not report to an employer, there is a different break-down of where your taxes are allocated.
While typical employees pay half the Social Security and Medicaid taxes (split with their employer), self-employment taxes take out the full lot altogether - or, 12.4% for Social Security and 2.9% for Medicaid, for a grand total of 15.3% in taxes for self-employed filings.
But, given that the tax burden is a lot heavier on those who are self-employed, what deductions are self-employed filers eligible for?
Self-Employment Tax and Deductions
While the taxes are certainly heftier for the self-employed, one major bonus is that you are able to subtract half of the self-employment tax from your total income.
Still, unfortunately for those who employ themselves, the 2017 Tax Cuts and Jobs Act eliminated a couple of self-employment tax cuts and deductions - but there are still a few you can take advantage of.
One big deduction you can capitalize on is a home-office deduction.
If you work out of a space used exclusively for your business, you can get a home-office deduction through the IRS for a business percentage deductible. This can even include things like property taxes, homeowner's insurance, utilities and more. If your office takes up about 10% of your home, you will be able to deduct 10% of those expenses from your annual expenses. The specifics of your deduction can be calculated with IRS form 8829.
However, since there isn't really a way to verify if your space is used exclusively for work purposes, the deduction is more on the honor system. But an IRS audit can quickly discover how your space is being used, which is something to keep in mind.
Additionally, a new tax law gives business owners of pass-through entities a 20% deduction on self-employed income on net business income - specifically for partners, "shareholders in S corporations, members of limited liability companies (LLCs) and sole proprietors," according to TurboTax. The benefit of having the deduction is that it will keep a larger portion of your earnings tax-free when filing your taxes. However, the deduction is only available on U.S. source income and only applies for your income tax - not your self-employment tax (although it will reduce your overall taxable income).
Another potentially big deduction is health care premiums. If you aren't on a spouse's health plan through their employer and pay for your own, you may be eligible to deduct your health, dental and certain long-term insurance premiums from your taxes. In addition, you may be able to deduct a spouse's or child's health premiums. To calculate your eligibility and deduction, review the IRS publication 535 and use the Self-Employed Health Insurance Deduction Worksheet.
You can also deduct business insurance premiums for things like credit or fire insurance for your business.
And among other deductions, you can also get deductions for advertising if you use Facebook (FB) ads, Google (GOOGL) ads, a website and more, as well as travel expenses like airfare, car rentals and more.
So while the self-employment tax is certainly a heavier burden than regular taxes, there are plenty of deductions that can help ease the load.