Self Employment written on Tax Form

What Is Self-Employment Tax?

2 min read • Dec 13, 2020 • Grant Olsen

When you work for an employer, they do quite a bit of work behind the scenes to make tax season easier for you each year. For example, they withhold FICA tax from your earnings every pay period. These withholdings are then used to pay your taxes for social security and Medicare. They will also prepare a W-2 form for you, which is an official document that discloses your wage and salary information. When you file your taxes, your W-2 provides details regarding how much you were paid and how much money was withheld for taxes.

But working for an employer probably isn’t for you—the fact that you’re reading this suggests that you have entrepreneurship in your blood. This means that you’ll need to handle your taxes on an individual basis, without the assistance of an employer’s financial team. 

So what is self-employment tax? It’s essentially the small business owner’s version of FICA tax, as it covers your social security and Medicare. In most cases, the dollar amount for self-employment tax is higher than what you would pay in FICA tax because you’re paying the full amount as a self-employed individual. When you work for someone else, the employer usually splits the burden and pays a portion for you.

It doesn’t matter whether you own a small business, work on a contractor basis, or just pick up freelance gigs. If you’re bringing in more than $399 a year, you probably owe self-employment tax.

Perhaps the next question on your mind is, “What is self-employment tax going to cost me?” To figure that out, you’ll need to crunch the numbers on your net earnings. No worries if you’re not a math whiz. The calculation simply subtracts your business expenses from your business revenues. If financial calculations were ski runs, this would be considered the bunny slope.

Once you’ve figured out your business revenue, you’ll need to compare it against the self-employment tax rate (which has a set percentage for social security and a percentage for Medicare). Your business revenue will determine how you need to handle self-employment tax, so it’s advisable to consult with your accountant. They are specially trained to help you figure out the best and most efficient way to take care of this tax obligation each year.

While you will always need to comply with tax laws, you have some control over how much self-employment tax you pay. One of the most popular ways to manage your tax burden is by strategically choosing your business structure. For example, you might save money in a sole proprietorship versus a partnership. If you have already set up your business as an entity and are unhappy with the results, sometimes you can change to a different structure that better matches your goals.

Other money-saving strategies include leveraging every possible deduction, finding tax credits, and investing in a qualified retirement account. You may be surprised how much you can lower your tax bill by paying closer attention to these details.

SHARE

Grant Olsen

Grant Olsen is a writer specializing in small business loans, leadership skills, and growth strategies. He is a contributing writer for KSL 5 TV, where his articles have generated more than 6 million page views, and has been featured on FitSmallBusiness.com and ModernHealthcare.com. Grant is also the author of the book "Rhino Trouble." He has a B.A. in English from Brigham Young University.