How to Calculate Your Self-Employment Tax

Every 90 days, or four times a year, I have to make my self-employment tax calculation to send to the IRS because I'm self-employed.  I have to confess it's not my favorite task. Let's be honest. Paying taxes isn't something any of us look forward to doing. However, calculating the amount of self-employment (SE) tax you owe and paying it isn't hard to figure out. You just need the know-how. This post provides instructions on the self-employment tax calculation, the rate to use, and deductions you can take to lower your federal tax liability. After reading this post, calculating and paying the SE tax won't seem so scary.

What is the Self-Employment Tax?

If you’re an employee, your employer pays quarterly employer taxes and your share of social security and medicare contributions called FICA taxes. You pay a combined percentage totaling 7.65%, and your employer matches the same amount. When you're self-employed, you owe the full percentage of SE tax on your business's taxable income.

If you just panicked because you aren't sure what that means, don't despair. I've included an example in the "how to calculate and pay self-employment tax" section below to eliminate any uncertainty you may have.

What is the Self-Employment Tax Rate?

Currently, the self-employment tax rate is 15.3% (12.4% for social security and 2.9% for medicare). In 2019, the IRS required you to pay self-employment tax on $132,900 of wages, tips, and net earnings. That amount increased to $137,700 in 2020. 

Who Has to Pay Self-Employment Taxes? 

Pass-through entities, such as sole proprietors, partnerships, S Corporations, and limited liability company owners, pay SE tax because profit and loss pass through to their personal tax returns. Shareholder owners of corporations don't pay this tax because they aren't considered self-employed.  Taxable entities who meet one of the following criteria set forth by the IRS must pay self-employment taxes:

• Net earnings from self-employment totals $400 or more (excluding church employee income).
• Church employee income totals $108.28 or more.

IRS regulations also indicate that the SE tax rule applies regardless of your age and even if you currently receive social security or medicare benefits. 

#CaminoTip Before we go over detailed instructions about paying this tax, it's important to point out that in this post we're only covering the basics relating to this topic. Contact a tax professional for more information on paying this tax based on your business structure or consider getting help by using tax software for small business owners.

How to Calculate and Pay the Self-Employment Tax?

Please note: The following outlined steps instruct you on how to figure SE tax on a business's calculated annual profit when preparing your annual federal tax return. See step 5 below on how to estimate SE tax each quarter.

1. What you need

To make the self-employment tax calculation, you must have a social security number or an individual taxpayer identification number (ITIN).

2. Taxable profit

Your next step is to determine your taxable profit after deducting expenses from your gross income. As stated earlier, your net earnings must fall within IRS guidelines.  If your business operates at a loss, you don't owe SE tax. As a side note, on the surface, that seems like a good thing. However, you won't be credited for social security and medicare contributions for any year you don't report income. When you don't have income to report, you could reduce your social security benefits when you retire.

3. Self-Employment tax calculation

Then, multiply your taxable profit by 92.35%.  For example, if your net annual business profit is $50,000, you would multiply that amount by 92.35% resulting in $46,175.00. That amount would be multiplied by 15.3% (the self-employment tax rate).  In this case, your SE tax would be $7,065. 

Please contact a tax professional on how to calculate SE tax on amounts over the $137,700 threshold for 2020 as the instructions are different depending on whether you use the short or long Schedule SE.

4. Fill in the amount you're paying

In the example I used above, you would enter the full amount of $7,065 under other taxes when completing IRS Form 1040.

5. Pay your SE tax

Because the IRS doesn't have a specific form to pay the self-employment tax, business owners send in SE tax with their estimated tax payments.  You can estimate your quarterly SE tax by using the same calculation method detailed in steps 2 and 3 based on income and expenses for each quarter.  The IRS wants you to pay at least 90% of your estimated federal and self-employment tax during the year. Otherwise, you may end up paying penalties and fines.

What are the Self-Employment Tax Deductions?

👉🏽    When you fill out Schedule SE, you'll notice you don't multiply your taxable income by 100% but 92.35%. The IRS gives you a deduction of 7.65%, equating to half of the 15.3% SE tax rate. 👉🏽    Additionally, on Schedule SE, you can figure a 50% deduction of the total self-employment tax owed as an adjustment to your taxable income.  This deduction doesn't reduce the total amount of self-employment tax you owe but reduces the taxable income you owe federal tax on.  Using the calculation example above, of the $7,065 SE tax that's due, half of that amount, $3,532, can be entered under the adjustments to income section on Form 1040 to reduce your adjusted gross income (AGI). 👉🏽    Don't forget to take common business tax deductions to decrease your taxable profit. You can also reduce your AGI by deducting health premiums paid for you, your spouse, and dependents. This self-employed health insurance deduction doesn't reduce the self-employment tax you owe. 

Life Just Got Easier

Knowing how to stay compliant with IRS regulations takes the pressure off so you can concentrate on building your business. Calculating and paying the tax on time is another way to learn how to run your business successfully. Because we want your business to succeed, we provide you with the educational resources you need to thrive. At Camino Financial, we can also help you achieve your business goals by offering financial products, like business loans for the self-employed. By having access to funding, you can keep your business moving forward.  Our goal is to come alongside you every step of the way as the driving force behind everything we do is wrapped up in our motto, "No Business Left Behind." Interested? Apply with Camino Financial! Apply For A Business Loan!