Lesson 22: Self-Employment Tax Basics
Welcome to Lesson 22 in the Self-Employment and Business Taxes section. In this lesson, we will explore the fundamentals of self-employment tax, covering key concepts, calculations, and important considerations. If taxes give you hives, don't worry—we'll make it as painless as possible!
What is Self-Employment Tax?
Self-employment tax is the tax that self-employed individuals must pay to cover their Social Security and Medicare obligations. Unlike employees who have these taxes withheld from their paychecks, self-employed individuals are responsible for calculating and paying these taxes themselves.
Who Needs to Pay Self-Employment Tax?
If you earn $400 or more in net earnings from self-employment, you are required to pay self-employment tax. This includes income from freelance work, business ownership, and independent contracting.
Calculating Self-Employment Tax
The self-employment tax rate is 15.3%, which consists of two parts:
- 12.4% for Social Security
- 2.9% for Medicare
Here is the formula to calculate self-employment tax:
\( \text{Self-Employment Tax} = \text{Net Earnings} \times 0.9235 \times 0.153 \)
Let's break it down with an example:
Net Earnings = $10,000 Self-Employment Tax = $10,000 \times 0.9235 \times 0.153 = $1,413.35
Reporting Self-Employment Income
Self-employed individuals must complete Schedule C (Form 1040) to report their income and expenses. The net profit or loss from Schedule C is then transferred to Form 1040.
Making Quarterly Estimated Tax Payments
Self-employed individuals are typically required to make quarterly estimated tax payments to avoid penalties. These payments cover both income tax and self-employment tax.
Self-Employment Tax Diagram
Conclusion
Understanding self-employment tax is crucial for anyone running their own business or working as an independent contractor. Make sure you stay compliant with tax laws and make timely payments to avoid penalties.
For additional reading on related topics, explore the following lessons: