The self-employed are taxed differently than employees are. It's all about withholding and employer matching. Here's how it works:
- When you're an employee, your employer withholds Social Security and Medicare taxes from your paycheck. Your withholding rates are 6.2% for Social Security and 1.45% for Medicare. Your employer also contributes matching amounts, for a combined payment of 15.3% of your income (that's 12.4% for Social Security and 2.9% for Medicare). Only the first $132,900 in income (for 2019) is taxed for Social Security. There is no maximum for Medicare.
- When you're self-employed, no one withholds, and no one makes matching payments. But the full 15.3% still has to be paid, and you're responsible for paying all of it yourself. But: Half of this is deductible, so you end up paying no more in these taxes than an employee would.
Your payment of Social Security and Medicare taxes is called self-employment tax. Don't confuse it with income tax (see below), which is additional.
Who Must Pay Self-Employment Tax?
In general, you must pay self-employment tax if:
- Your net earnings from self-employment were $400 or more, or
- You had church employee income of $108.28 or more.
If you earned enough self-employment income, you must pay self-employment tax regardless of your age, even if you’re a minor dependent or are retired and already receive Social Security or Medicare benefits.
Net earnings are calculated by subtracting deductible expenses from your gross self-employment income. Use Schedule SE to figure your net earnings from self-employment and the amount of self-employment tax you owe.
Your self-employment earnings are also subject to income tax. The amount of taxable income is figured slightly differently than for employees, because of the much greater range of allowed deductions. One of the deductions is for half of your self-employment tax. So even though you have to pay the entire self-employment tax, you get half of it back when you prepare your return.
So What Are Estimated Taxes?
Some people confuse self-employment tax with estimated taxes, which are more properly called estimated tax payments. Whatever you call them, they aren't a different or separate tax, but merely how you pay your self-employment and income taxes all year long. Remember, taxes are pay-as-you-go, and estimated tax payments are how you pay as you go. See Estimated Tax Payments for more details about how the payments work.