Self-Employment Taxes Explained

Self-employment Taxes Explained
Self-employment Taxes Explained. Hero Images/Getty Images

If you own your own business (not a corporation), you are considered to be self-employed, and you must pay self-employment taxes. These self-employment taxes are taxes paid self-employed business owners to the Social Security Administration, for Social Security and Medicare.

In this article, we'll discuss how self-employment taxes are calculated, what income they are based on, and how they affect business owners in various types of businesses.


What are Self-employment Taxes?

The term "self-employment taxes" describes those taxes that someone who is a business owner must pay. You must pay these taxes on your total net earnings from your business each year. Specifically, self-employment taxes are for (1) Social Security benefits and (2) Medicare benefits. 

How Does My Business Type Affect Self-employment Taxes? 

Self-employment tax is due on the income of all small businesses, including sole proprietors, partners in partnerships, and LLC owners. If you are the owner of a corporation, you don't pay self-employment taxes, although you may pay Social Security and Medicare taxes in the form of FICA taxes if you work as an employee in the corporation. 

So How Do Self-employment Taxes Differ from "Employment Taxes"?

Everyone who is employed in the U.S. must pay taxes for Social Security and Medicare. For employers/employees, these are called FICA taxes.

(FICA stands for “Federal Insurance Contributions Act.") FICA has two parts: the first is Social Security (actually called Old Age, Survivor, and Disability Insurance, or OASDI), and the second is Medicare.

The Social Security portion of the tax is 12.4% up to $102,000 (in 2008) and the Medicare portion is 2.9%.

Employees pay half of this tax and their employers pay the other half. Self-employed individuals pay the entire amount.

Employees have OASDI and Medicare deducted from their gross income before taxes; the OASDI deduction is 6.2 percent and Medicare is 1.45 percent for a total of 7.65 percent. If you are self-employed, you must pay the entire 15.3 percent, based on the profits of your business.

How is the Self-employment Tax Calculated?

When you fill out your personal income tax return, you include your net income from self-employment. this income is then used to calculate the amount of self-employment tax you owe for the year. Here's how it works:

1. The amount that's taxable for self-employment tax purposes is your business net income. Your business net income is your gross income from your business less your deductible expenses.

2. The calculation for self-employment tax is done on Schedule SE. This calculation is complicated, and there are several ways to run the calculation. You can do it yourself, but it's best to get a tax preparer or a tax preparation program to do this calculation. 

3. The total amount of the tax is then brought on to your Form 1040 on Line 58. Any amount you owe for self-employment tax is added to your personal tax liability for the current year and is paid to the IRS.


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