What Is Self Employment Tax?

The advent of the COVID-19 pandemic has resulted in some dramatic changes to the world’s workforce. One of the most profound effects has been the shift from an on-site to a work-from-home economy. One result of this shift is an increase in the number of workers operating as independent contractors.

If you’ve experienced this transition from a full-time, in-house employee to an independent contractor, or if you’re pursuing a career as a freelance or contract employee, there are some important facts that will shape your tax picture.

What Is Self Employment Tax?

The term self-employment tax typically refers to the Social Security and Medicare portion of taxes paid by self-employed workers, much like the FICA withholding that deducts these payments from the checks of in-house workers.

When an independent contractor bills for work, they keep what they receive. This means they incur a tax obligation that they (as both employer and employee) are responsible to pay. Independent contractors are required to make quarterly estimated tax payments throughout the year, to keep pace with their tax obligations.

Who Needs to Pay Self-Employment Tax?

If you are an independent contractor working offsite, you’ll likely be required to pay self-employment tax. Also, if you typically receive a 1099, rather than a W-2, from your employer, you are regarded as an independent contractor and are required to pay self-employment tax. The idea behind the current system is to require the self-employed to make contributions to Social Security and Medicare comparable to those made by in-house workers.

Types of workers who need to file self-employment tax include pass-through business types such as independent contractors and freelancers, partners in active partnerships, S-corporation owners, and limited liability company (LLC) owners.

How Is Self-Employment Tax Calculated?

The amount of self-employment tax you owe can be calculated using Schedule SE, which calculates the Social Security and Medicare tax on profits made by independent contractors.

The maximum amount of net earnings subject to the Social Security tax is established by law. Anything above that amount is not subject to the tax. The maximum amount has increased incrementally over time and currently stands at $137,700 for the 2020 tax year. The portion devoted to Medicare applies to all your earnings, regardless of amount.

Also, since 2013, the Affordable Care Act adds an additional 0.9% Medicare surtax on income above a given threshold, which currently stands at $200,000 for single filers, $250,000 for joint filers, and $125,000 for married couples who file separately. Note: If you file a joint return with another self-employed person, you must calculate your self-employment taxes separately.

Effect on Independent Contractors

The current self-employment tax rate is 15.3%, with 12.4% going to Social Security (7.65% employee share and 7.65% employer share) and 2.9% (1.45% employee share and 1.45% employer share) to Medicare. If you earned more than $400 from independent income during the previous year, you are required to file self-employment tax.

  • As an independent contractor, you may be able to deduct half of the self-employment tax you pay annually on your return.
  • If you work from home and dedicate a portion of your residence to work, you may be able to avail yourself of a home-office deduction, which allows you to deduct part of your monthly rent or mortgage payment.
  • If you are self-employed and cover the cost of your how health insurance premiums, the you can deduct any premiums paid for health, dental, and long-term care insurance.
  • Other items that may be deductible include internet and phone bills, expenses related to travel, vehicle expenses and meal, rent, interest on business loans and education expenses.

Working for yourself has its perks, but paying the self-employment tax is not one of them. As a self-employed individual you also have opportunities to deduct many business expenses tp help reduce your taxable income. Partnering with an experienced tax advisor can help you navigate the often-complex tax landscape of the self-employed. At Moskowitz LLP, we understand how important your business, and your earnings, are to you. That’s why our experienced tax experts work with each client, so you never pay a penny more than you owe. If this is your first time filing as an independent contractor, don’t go it alone. Contact us today!