The self-employment tax is a special tax typically paid by small business owners to the federal government. It is levied to fund Medicare and Social Security. A self-employed individual is a person who runs a business for himself and takes responsibility for the success or failure of the business. It is a fairly broad definition and includes various forms of employment, such as part-time work and even starting your own company. In the United States, a self-employed person can do business as a sole trader, an independent contractor, or a member of a partnership. All self-employed people must pay the tax.
Once you have earned $400 after all expenses ($108.28 for church workers), you must start making regular payments to Social Security and Medicare funds. It would help if you did this until your profit reached $118,500 in the case of Social Security. Medicare payments are not dependent on income.
Subtleties of taxation
Self-employed persons are subject to taxation as a condition of receiving Social Security benefits after retirement. In any enterprise, the company and the employee will be taxed when it comes to business. They all must pay tax for the leading social programs Medicare and Social Security. Nevertheless, when workers are self-employed, the IRS considers such people as both a company and an employee, and they must pay two parts of the tax.
What is a self-employment tax?
The low tax rate is one of the features and benefits of this tax. Self-employment tax in the USA means only Social Security tax and Medicare tax. It does not include any other surcharges to pay. Self-employed may be persons from various areas of personal services, such as:
- agriculture;
- medicine;
- art;
- sales and other areas of activity.
This category of citizens is required to pay a special self-employment tax (SET). It equals 15.3% of profits (12.4% is credited to social funds, and 2.9% is medical insurance).
At the same time, the most significant amount of income received that is taxable is $137,700. The minimum amount is $400. The income below this value is not taxed.
The payment guarantees the right to social security and medical care, including after retirement. A self-employed person may pay an additional Medicare tax (Additional Medicare Tax) of 0.9% if the net income from working as a self-employed person exceeds the threshold (depending on taxpayer status).
How to count taxes?
Fill out Appendix C (Schedule C) to form 1040, get the taxable income (line 31 in the Appendix) and multiply this amount by 92.35%. If the result is $400 ($108.28) or less, you don’t have to pay tax. If this amount exceeds $400 ($108.28), you are a taxpayer. This tax is paid regardless of the age of the entrepreneur and whether they are a recipient of Social Security payments.
What is this tax for?
Self-employment tax goes to the federal fund, which finances social benefits, payments to the elderly, people with disabilities, and victims of accidents and natural disasters. After each tax payment, the amount transferred is recorded in the profile with the accrual of points.
Features of the tax
The self-employed person can pay social security and medical insurance tax once. Suppose the self-employed person combines work with employment. In that case, Form C or C-EZ (Form 1040) indicates that the employer paid the social security tax. This tax is not entitled to pay a lawyer, accountant or banker, public notary, and those self-employed who are engaged in gambling. Children under 18 do not deliver this tax if they work for their father or mother.
Resident foreigners who are self-employed must pay tax under the same rules for US citizens. Nonresident self-employed foreigners do not pay tax unless this obligation results from an international agreement on social security. The US social security system effectively covers them.
Calculating taxable income methods
There are three methods to calculate income subject to self-employment tax:
- standard method;
- an optional way for non-farm enterprises;
- an optional method for farms.
With the optional method, SET is increased (on retirement, the self-employed person will claim more significant benefits).
The financial burden of the taxpayer on the NAP is the obligation to pay: 4% — concerning income received from the sale of goods (works, services, property rights) to individuals; and 6% — pertaining to gain from the sale of goods (works, services, property rights) to individual entrepreneurs for use in entrepreneurial activities and legal entities. Reporting self-employment tax is done by filing Form 1040 with the SET amount to the IRS.
When to pay self-employment tax?
Self-employment income is worth paying if a person’s income from self-employment is $400 or more during the year. Moreover, Form SE must be filed along with Form 1040, which usually must be submitted by April 15. However, suppose a person thinks they owe $1,000 or more in combined income and self-employment taxes. In that case, they must make estimated quarterly tax payments.
Estimated payment dates are usually April 15, June 15, September 15, and January 15 of the following year. These dates roll over to the next business day if 15 falls on a weekend or holiday.
The people who have to pay this tax can estimate the amount they have to pay. Algorithms 8 of Form 1040-ES can be used. These tax forms will help a person determine the amount they owe during the year, divide it by four, and pay it in equal installments on time. The form also includes vouchers, which must be attached when mailing payment. You can also use a free tax calculator to calculate the estimated amount of tax you need to pay.
Can I deduct self-employment tax?
When a person pays self-employment taxes, they essentially receive a tax deduction when filing their federal income tax return. A person can deduct half of the self-employment tax from the adjusted gross income and reduce the amount of taxes. For instance, if a person calculates their $4,000 self-employment taxes, they receive a $2,000 tax deduction from taxable income.