Before you became a successful entrepreneur, you were probably an employee of another company and you received a paycheck for the hours that you worked. As an ordinary wage earner, half of your Social Security and Medicare taxes were automatically deducted from your paycheck and the other half was paid by your employer.
However, now that you are self-employed and you wear both the employee and the employer hats, you have to pay both the employer and employee portion of your social security and Medicare taxes. We recommend TurboTax to make the filing process much easier and reduce the chance of errors that could cost you bigtime.
In this article, we will answer your questions regarding self-employment taxes by covering the following topics:
- How Do I Know if I Have to Pay Self-Employment Tax?
- Do I Have to Pay Self-Employment Tax if I am the Owner of a Corporation?
- How much Self-Employment Tax Do I Owe?
- What Tax Form Do I Need to Use to Report Self-Employment Tax?
- When Do I Need to Pay Self-Employment Taxes?
- How Do I Reduce Self-Employment Tax?
Please note that this article contains general information only. We recommend consulting your tax professional for advice about your specific situation.
How Do I Know if I Have to Pay Self-Employment Tax?
If you had net earnings of $400 or more in self-employment income then you must pay self-employment tax. This includes but is not limited to the following entities:
- Sole proprietors
- Partners in a partnership
- Members of an LLC
- Independent contractors such as Lyft/Uber drivers who received a 1099-MISC form
Do I Have to Pay Self-Employment Tax if I am the Owner of a Corporation?
There are two types of corporations, S Corp and C Corp. Both types of corporations protect shareholders from being sued so that they are not at risk of losing their personal assets if a lawsuit is filed against the business.
For tax purposes, an S Corp is not taxed so all business income and expenses are passed down to the shareholders and reported on Schedule K-1. Therefore, the owner of an S Corp would have to include any income reported on Schedule K-1 as Net Self-Employment income on Schedule SE to calculate self-employment tax.
A C corporation is considered a separate legal entity for tax purposes. If you’re the owner of a C corporation, you can be taxed twice, once as a corporate entity and then again on any distributions paid to you in the form of dividends. You are required to pay income tax on any distributions that you receive from the business. However, this income is not subject to Self-Employment tax.
As the owner of a C corporation, you are subject to self-employment tax if you receive compensation that is not reduced by social security and medicare taxes. In this case, the corporation would issue a 1099-MISC form to you, and you would have to report that income as self-employment income on Schedule SE. In general, most owners of a C Corporation receive a salary like regular employees so they don’t pay self-employment taxes.
How Much Self-Employment Tax Do I Owe?
To determine how much self-employment taxes you owe, you will need to know what your total net profit or net loss from your business is. As a business owner, there are a few ways to get this figure:
- If you are a Sole Proprietor or single-member LLC, then complete your Schedule C first & the Net Profit (Loss) figure from Line 31 is your self-employment income (loss).
- If you are a Partnership or multi-member LLC that files Form 1065, then refer to your Schedule K-1 for the Net Profit (Loss) figure. This is your self-employment income (loss).
- If you are an Independent contractor, refer to your 1099-MISC form for the Net Profit(Loss) figure. This is your self-employment income (loss).
If you use an accounting program like QuickBooks, run your profit and loss report for the tax year (i.e. January 1-December 31). The bottom line Net Profit (loss) is your self-employment income (loss).
Once you have your self-employment income, use the following table to determine your self-employment tax rate.
Self-Employment Tax Rate Table for 2016 Tax Year
|If your net self-employment income is..||This is your self-employment tax rate||You pay self-employment taxes on..|
|Under $400||You don’t have to pay self-employment tax||You don’t have to pay self-employment tax|
|$400-$200K - single filers|
$400-$250K - married joint filers
$400-$125K - married filing separate
|15.3% of net self-employment income. Here is the breakdown:|
(12.4% for social security (up to a max of $118.500) + 2.9% for medicare tax)
|Pay self-employment taxes on 92.35 % of your income.|
|Above $200K - single filers|
Above $250K - married joint filers
Above $125K - married filing separate
|16.2% of net self-employment income. Here is the breakdown:|
(12.4% for social security up to $118,500 in income + 3.8% for medicare tax)
|Pay self-employment taxes on 92.35 % of your income|
NOTE: if you file a joint return with your spouse, be sure to combine your spouse’s income with your own to determine your self-employment income and tax rate.
It is important for you to know that only 92.35% of your self-employment income is subject to self-employment taxes. This is because the IRS allows you to deduct half of of your self-employment tax when calculating your net earnings.
Let’s look at a couple of examples of how you would calculate the amount of self-employment tax owed:
Example 1: Let’s say that you own a restaurant, and the net earnings for 2016 were $100,000. To figure out your taxable self-employment income, multiply this amount by 92.35 %, which equals $92,350. Then, apply the 15.3% tax rate to this amount. This shows that you owe $14,130 in self-employment taxes.
Example 2: Let’s say you own a booming plumbing business, and the net earnings for 2016 were $150,000. Multiplying this by 92.35 % tells you the taxable self-employment income, which is $138,525. Only $118,500, however, is subject to Social Security tax, so your Social Security tax is $118,500*12.4% = $14,694. The Medicare portion of the tax applies to the full $138,525, so your Medicare taxes are equal to 138525*3.8% = $4,017. When you add up the Social Security and Medicare taxes, you’ll see that you owe a grand total of $18,711 in self-employment taxes.
What Tax Form Do I Need to Use to Report Self-Employment Tax?
Business owners must use Schedule SE to compute and report self-employment taxes. This form should be filed along with Form 1040.
If you were subject to the 16.2% self-employment rate then you must also file Form 8959 to report the additional medicare tax paid.
If you do your own taxes, try TurboTax, our recommended tax software for small businesses. TurboTax will calculate your self-employment taxes for you and complete Schedule SE and any supplemental forms for you.
When Do I Need to Pay Self-Employment Taxes?
If you were taken by surprise with a sizable tax bill this year, you might want to consider making quarterly payments throughout the year. You can use IRS Form 1040 ES to estimate your quarterly payments. If you use TurboTax software, it will calculate your quarterly tax payments and complete all of the necessary forms for you.
Keep in mind that if you underpay your taxes by more than $1,000, the IRS may charge a penalty when you file your tax return. The amount of the penalty depends on a number of factors such as whether or not you were late with more than one payment as well as the number of days the payment was made after it was due. There are two methods for calculating the penalty, and the IRS Pub 505 provides step by step instructions on how to calculate the penalty for both methods.
In the table below are the estimated due dates for each pay period. As long as your payment is postmarked by the Payment Due Date, it will be considered on time by the IRS.
Due Dates for Estimated Self-Employment Tax Payments
|Pay Period||Payment Due Date|
|Jan 1 - Mar 31||April 15|
|Apr 1 - May 31||June 15|
|Jun 1 - Aug 31||September 15|
|Sept 1 - Dec 31||January 15 of the following year|
The IRS offers a variety of ways to make tax payments. I recommend using the Electronic Federal Tax Payment System (EFTPS). This is a free tool offered by the Department of Treasury, and you can use it to schedule payments in advance so that you don’t forget.
According to the EFTPS website, it can take up to 7 business days to receive your PIN, which is required for you to login and make payments. Make sure you apply well in advance of any deadlines. Click here for information on other payment options that are available.
How To Reduce Your Self-Employment Tax
Two ways you can reduce your self-employment tax without getting the attention of the IRS are:
- Take more business deductions
- Change your business structure to an S Corp or an LLC taxed as an S Corp
If you take advantage of all of the deductions available to you then you can reduce your taxable income which will reduce your income tax liability and self-employment tax liability. In general, small businesses are able to deduct home office expenses, travel and entertainment expenses, startup costs, and any other reasonable or necessary expenses for your trade or business. Be sure to keep good records just in case you ever have to prove to the IRS these were legitimate business expenses.
To learn more about tax savings that you may be missing out on, read our Business Tax Saving Tips article.
If you decide to change your business structure to an S Corp or an LLC taxed as an S Corp, this could reduce the amount of self-employment tax that you pay because corporations have more allowable deductions, and you could pay yourself a salary so that you only pay half of your social security and medicare tax and the corporation pays the other half. However, there are several requirements that must be met to qualify as an S Corp. Be sure to consult with a tax professional to determine if changing your business structure makes sense for your business.
State and Local Tax Obligations
In this article, we have primarily focused on your tax responsibility at the Federal level. Federal law controls self employment taxes because social security and medicare are mandated at the federal level. However, states and localities may have additional or different income tax laws. To learn more about your tax responsibility at the state level, click here.
Unfortunately, as long as you are in business for yourself, there is no way around paying self-employment tax. The good news is there are ways for you to reduce those taxes and avoid penalties. Below I have listed a few steps that you can take to potentially reduce your self-employment taxes:
- Use a tax software program like TurboTax, our recommended tax software, to prepare your tax return. It will scan your return to ensure that you maximize your deductions.
- Make estimated tax payments throughout the year to avoid underpayment penalties.
- Consider changing your business structure to an S Corp or an LLC taxed as an S Corp. Read our Best Business Structure article to learn more about how to select the right business structure.
- Check out QuickBooks Self-Employed. It is designed specifically for sole proprietors, independent contractors, and freelancers like you to keep track of all income and expenses to make tax time much easier.
- Consult a tax professional to get advice on your specific situation.