Self-employment tax is a tax consisting of the Social Security and Medicare taxes primarily for individuals who work for themselves. It covers contributions to both Social Security (old-age, survivor’s, and disability insurance) and Medicare (hospital insurance).
Components of Self-Employment Tax
Social Security Tax
The Social Security portion of the self-employment tax helps fund the Social Security benefits that cover retirement, disability, and survivors’ benefits. For self-employed individuals:
- 2011 Rate: 10.4% on net earnings from self-employment up to $106,800.
- 2012 and Beyond: 12.4% on net earnings up to the Social Security wage base limit.
Medicare Tax
The Medicare portion of the self-employment tax helps fund hospital insurance (Medicare Part A). For self-employed individuals:
- 2011 Rate: 2.9% on total net earnings from self-employment.
- 2012 and Beyond: Remains at 2.9% on total net earnings.
Historical Context and Rate Changes
In 2011, the Social Security rate was temporarily reduced to 10.4% as part of an economic measure to stimulate the economy. Typically, the combined self-employment tax rate is 15.3%, which comprises 12.4% for Social Security and 2.9% for Medicare. This rate matches the total contributions made by both an employer and an employee.
Calculation and Payment of Self-Employment Tax
Self-employed individuals calculate their self-employment tax using Schedule SE (Form 1040). The tax is then added to their income tax on Form 1040.
Example Calculation
For an individual with $50,000 in self-employment net earnings in 2012:
- Social Security Tax: \( 50,000 \times 12.4% = 6,200 \) USD.
- Medicare Tax: \( 50,000 \times 2.9% = 1,450 \) USD.
- Total Self-Employment Tax: \( 6,200 + 1,450 = 7,650 \) USD.
Estimated Tax Payments
Self-employed individuals must make estimated tax payments quarterly if they anticipate owing at least $1,000 in self-employment tax.
Special Considerations
Deductions for Self-Employment Tax
A self-employed individual can deduct the employer-equivalent portion of the self-employment tax. This deduction only affects their income tax, not the self-employment tax.
Thresholds and Limits
While Medicare tax is applied to all net earnings, the Social Security tax only applies up to a certain limit, known as the wage base limit, which can change annually based on national average wage indexes.
Related Terms and Definitions
- Schedule SE (Form 1040): A form used to calculate the self-employment tax due on net earnings.
- Net Earnings from Self-Employment: Gross income from a business less allowable business expenses.
- FICA Tax: Federal Insurance Contributions Act tax paid by both employees and employers to fund Social Security and Medicare.
- Social Security Wage Base: The maximum income subject to Social Security tax, which adjusts yearly.
FAQs
Do I need to pay self-employment tax if I have a full-time job and a side business?
Can I deduct expenses from my net earnings?
What forms do I need to file for self-employment tax?
Is there a penalty for not paying estimated taxes?
References
Summary
Self-employment tax is a crucial part of being self-employed, ensuring contributions to Social Security and Medicare. It is important for self-employed individuals to understand the components, calculation methods, and obligations towards quarterly payments to stay compliant and avoid penalties.
