What is the Self Employment Tax?

Whether you’re new to freelancing or you’ve had a sole proprietorship for years, when you own your own business, you take on a whole new assortment of responsibilities when it comes to tax time. One of the most common questions we get from new freelancers is: What is the self employment tax?

The self employment tax (SE tax) is the fee that you pay to the federal government to cover the cost of social security and medicare when you’re self employed.

For many people, the self employment tax comes as a surprise, as it’s not something you’re used to paying when you work for someone else. Unfortunately, there’s also a lot of misinformation out there about taxes for freelancers, which is why we’re here to help clear the air.

Coming up, we’ve got your ultimate guide to the self employment tax, including information on what it is, how much you need to pay, and when you need to pay your self employment tax on your earnings. Let’s get to it!

What is the self employment tax?

As we’ve already discussed, the self employment tax is the amount that an individual pays to the federal government to cover their share of social security and medicare when they receive wages from self employment work. While this may seem like a “special tax” for freelancers, it turns out that employees pay it, too – it just happens to be withheld from their paychecks each month.

If you’ve ever received a pay stub from an employer, you’ll notice that there’s a deduction set aside for “FICA” taxes (Federal Insurance Contributions Act). These are the fees you pay toward social security (your federally sponsored retirement and disability insurance) and medicare (health insurance for older folks).

When you’re employed by a company, 6.2% of your paycheck is withheld for social security benefits while an additional 1.45% is withheld for medicare (as of 2019). As an employee, your federal income tax is also withheld from your paycheck, according to the withholding rates you calculate on your W-4. This happens automatically, with no extra leg work on your part when you work for someone else.

When you don’t receive regular paychecks from an employer where taxes are automatically withheld, however, you need to pay your own taxes directly to the IRS. This is where the self employment tax comes in the picture.

How much is the self employment tax?

The self employment tax rate, as with all tax rates, changes frequently. In 2019, the self employment tax rate is 15.3%. Does this sound like a lot? That’s because it is.

In fact, if you do the math, the self employment tax (the sole proprietor’s version of FICA) is exactly twice the amount that an employee pays for the same services. How does that compute?

Well, it turns out that when you’re employed, your employer has to pay half of your FICA taxes. This means that the actual FICA tax for individual employees is 15.3%, but your employer pays half of what you owe for you. You would never know this based on your pay stubs, which is why the self employment tax is such a surprise to new freelancers.

Who needs to pay the self employment tax?

At this point, you’re probably asking yourself: Do I need to pay the self employment tax? Here’s the IRS’s answer:

You must pay self-employment tax and file Schedule SE (Form 1040) if either of the following applies.
1. Your net earnings from self-employment (excluding church employee income) were $400 or more.
2. You had church employee income of $108.28 or more.

IRS.gov (2019)

Basically, if you’re not a church employee and you made more than $400 in self employment or freelancing income this year, you’re liable for self employment taxes. So, if you sold $399 worth of earrings on your Etsy shop, you’re off the hook. Otherwise, you need to pay up.

That being said, there are special rules for certain freelancers, especially people who work as family caregivers. You can learn more about those special rules here.

Do freelancers pay more in taxes than employees?

Now that you know how much more you need to pay in self employment tax as a freelancer, you might be wondering if freelancers pay more in taxes than regular employees. The unfortunate truth is that, yes, freelancers almost always pay more in taxes than employees.

Since freelancers need to pay both the additional self employment tax and their regular income tax based on their income level, they do, on average, end up paying more in tax than regular employees. Generally, most accountants recommend that freelancers plan to put aside upward of 40% of their income (even more if you’re a high earner or if you live somewhere with high state taxes) toward taxes each year.

When you compare this to a regular W-2 employee, this is quite a bit more. The main difference between a W-2 employee and self employed individual, however, is that the freelancer needs to pay that extra 7.65% toward the self employment tax that the W-2 employee gets paid for them.

What is the self employment tax deduction?

While it is true that freelancers pay more, on average, than a W-2 employee in taxes each year, there are quite a few tax breaks that freelancers can take advantage of, if they’re in the know.

Perhaps the most important tax deduction for freelancers, at least when it comes to the self employment tax, is the aptly named “Self employment tax deduction.”

What is this mysterious deduction, you might ask? Basically, it’s a way to deduct the amount of extra money you’ve had to pay in self employment taxes (when compared to a W-2 employee) from your overall income.

Basically, you can deduct half of what you paid in self employment tax for the year from your total adjusted gross income on your Form 1040. This means that if you made $100,000 this year from all of your income sources and paid $5,000 in self employment tax, you can adjust your total income to be $97,500 thanks to your new $2,500 deduction.

Since this is a deduction and not a credit, this tax break doesn’t directly decrease the amount you owe. Rather, it reduces your taxable income that’s used to figure the overall amount of federal income tax you need to pay.

Think of it as a small break for paying more than other folks, not a complete reparation for the extra money out of your wallet just for being entrepreneurial.

How do I pay the self-employment tax?

Unfortunately, many people begin their self employment career totally unaware of the self employment tax. As you can imagine, this comes as quite a shock to many new freelancers come tax time.

In fact, If you don’t pay your taxes during the year and you owe more than $1000 come tax time, you actually might get another fee slapped on top of the amount you owe. Ouch.

The solution? Don’t let this be you. Pay your self employment tax throughout the year as a part of your quarterly estimated taxes (more on this in another article).

How do you pay your self employment taxes? It’s actually quite easy, though there are a number of different ways to do it.

By far, the easiest way to pay your self employment and quarterly estimated taxes is through the government’s Electronic Federal Tax Payment System (EFTPS). This is a completely free service provided by the US Department of Treasury and it’s pretty simple to use.

To pay your taxes through the EFTPS, you’ll need to make an account. While making the account itself doesn’t take much time, you’ll need to receive a PIN in the mail, which takes a while. So, plan ahead and do this well ahead of the tax deadline for your quarterly schedule.

You can even connect your EFTPS account to your Quickbooks Self Employed account for any easy way to pay your estimated taxes. Since Quickbooks Self Employed estimates your tax payments for you, this is a super convenient, streamlined system for paying the feds on-time each quarter.

Another method for paying your self employment tax is to use the IRS Direct Pay system. Direct Pay allows you to pay your estimated taxes straight from your bank account.

Alternatively, you can use the IRS2Go Mobile App to pay your estimated taxes, check your tax refund status, or find free tax preparation assistance. This app works well on both Apple and Android devices, so it’s pretty handy. You will need to verify your identity before using it, though, so have your last two tax returns handy to get started.

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