How to Plan For and Minimize the Self-Employment Tax
Updated September 2024
Are you self-employed? Being self-employed has many benefits. You can set your own hours and decide what jobs you take. However, you cannot escape paying federal income taxes. Our Maryland tax attorney discusses self-employment tax in this article, including ways to prepare for and minimize self-employment tax.
What Are Self-Employment Taxes?
In addition to income tax, you need to pay self-employment (SE) taxes. Your self-employment tax supports the Social Security and Medicare programs, just like tax withholding for an employee. The self-employment (SE) tax is the equivalent of the FICA (Federal Insurance Contributions Act) taxes paid by employees and employers. FICA comprises Social Security and Medicare taxes. Employees and employers pay one-half of the amount due in FICA taxes. When you are self-employed, you are responsible for paying the entire amount due in FICA taxes in addition to your income tax.
Congress passed a law in 1954 that made self-employed individuals subject to the same taxes as employees under FICA. If you earn over $400 in self-employed income, you must pay Social Security and Medicare taxes. The first step is to determine what is considered self-employment income. Self-employment income includes income earned from:
A business or trade as a sole proprietor or independent contractor;
Being a member of a partnership; and,
Selling a service or product, including a gig worker and operating a part-time business.
Self-employed individuals earning $400 or more must file a tax return, including a Schedule SE, to calculate the amount they owe in self-employment tax. A church employee is required to pay self-employment tax if they receive more than $108.28 from a church or qualified church-controlled organization.
Self-Employed Tax Rates for 2023 and 2024
Generally, employees pay 6.2% of their gross income for Social Security tax, with the employer matching that amount for Social Security tax. Employees also pay 1.45% of their gross wages for Medicare taxes, with the employer matching that amount for Medicare tax. The total FICA taxes equal 15.3% of the person’s gross wages on annual earnings up to $168,600.
Therefore, the self-employment tax rate for 2024 for FICA taxes is 15.3 percent if your earnings are no greater than $168,600. You must pay self-employment taxes and the matching portion that an employer would typically pay for Social Security and Medicare taxes.
How to Calculate Self-Employment Income and Tax
If you have net earnings from self-employment of $400 or more, you must pay self-employment tax. The maximum amount of self-employment income subject to social security tax in 2023 is $160,200 and $168,600 for 2024. Always verify the current year’s income limits by referring to the IRS publication explaining how to calculate Schedule SE for Form 1040.
Generally, 92.35% of your net self-employment earnings are subject to self-employment tax. Your net earnings are calculated by subtracting necessary and ordinary business expenses from the gross income you earned from your business or trade.
Tax Deductions for Self-Employment Tax
There is no way to reduce the self-employment tax rate. However, you can reduce your taxable income from self-employment through tax deductions. Using tax deductions is one of the best ways to minimize the amount of self-employment tax you owe by lowering your adjusted gross income. Your tax obligation decreases as your net earnings decrease.
Being extremely thorough when preparing Schedule C to report self-employment income and expenses is crucial to ensure you claim each business expense available. There are more than 500 deductions and credits you may claim to reduce net earnings from self-employment. The type of credits and deductions available depends mainly on the services or products you sell.
Examples of Common Business Expenses That Are Deductible From Gross Earnings on Schedule C Include:
Office rent
Home office deduction
Business equipment
Utilities
Cell phone and internet
Office supplies
Advertising and promotion expenses
Vehicle expenses
Contract labor and employee wages
Fees and memberships
Business insurance and professional services
Interest on loans
Travel, meals, and entertainment
Depreciation
Repairs to business property
Qualified health insurance premiums
Qualified retirement plan contributions
Tracking spending for your business helps you avoid missing valuable tax deductions that could lower your self-employment tax. Detailed bookkeeping is the key to identifying deductions and credits.
Are There Alternate Methods for Calculating Self-Employment Taxes?
Alternative methods for calculating self-employment tax could minimize your tax obligation. Optional methods for calculating SE tax can give you credit toward your social security coverage. It could also qualify you to claim the earned income credit (EIC), child or dependent care credit, or additional tax child tax credit (ACTC).
In some cases, the optional methods could give you a more considerable credit if your net earnings from self-employment are less than $6,040 without using the optional method.
There are two optional methods for calculating self-employment tax:
Farm Optional Method
This option is available if your gross farm income or net farm profits are below the amount set for a specific tax year. You should refer to the Instructions for Schedule SE for the tax year you are filing for the current amounts. For 2023, the maximum gross farm income for this method is $9,840, and the maximum net farm profits were $7,103.
Non-Farm Optional Method
To use this method, you must be regularly self-employed, which means your net earnings from self-employment was more than $400 in two of the past three years. Your current net non-farm income must be below the maximum set for the filing year ($7,103 for 2023) and less than 72.189% of your gross non-farm income. You can only use the non-farm optional method for SE taxes for five years. The five years do not need to be consecutive.
Do I Need to Pay Additional Medicare Tax?
Additional Medicare Tax was implemented in 2013 as part of the Affordable Care Act (ACA). It applies to wages and self-employment income over specific amounts. You may be required to pay additional Medicare Tax if your income exceeds the following amounts based on your filing status:
Married filing jointly $250,000
Married filing separate $125,000
Single $200,000
Head of household $200,000
Qualifying widow(er) with dependent child $200,000
The additional Medicare Tax rate is .09% of wages and income subject to Medicare taxes. Additional Medicare Tax is reported on IRS Form 8959.
How Do I Pay Self-Employment Tax?
Self-employment tax is reported on your annual income tax return. When you file your annual tax return, attach Schedule C to report income and expenses from self-employment. To report your SE tax, file Schedule SE with your tax return. Schedule SE calculates your self-employment tax for Medicare and Social Security. If you have unpaid self-employment tax, they are added to the amount of income taxes you owe for the filing year.
Should I File Estimated Taxes?
Technically, taxes must be paid as you earn or receive income during the year through tax withholding or estimated tax payments. Generally, self-employed individuals are required to pay estimated tax payments if they expect to owe more than $1,000 in taxes for the year.
Estimated tax payments include income taxes, self-employment tax, and the alternative minimum tax. Form 1040 ES (Estimated Tax for Individuals) is used to calculate quarterly payments for estimated taxes. You use the prior year’s annual tax return to calculate your estimated taxes for the current tax year.
Paying estimated taxes is an excellent way to avoid a large tax bill each year. It also prevents paying a penalty for failing to pay taxes throughout the year. You could owe a penalty if your estimated taxes are late, even if you receive a refund on your tax return.
Have FICA Taxes Gone Up in Recent Years?
According to the Social Security Administration (SSA), the rate for self-employment tax has been 15.30% since 1990. From 1988 through 1989, the rate was 15.20 percent. There does not appear to be an increase in the self-employment tax rate for the current or future tax years. However, Congress can change the tax rates by passing new tax laws, so you should always check current tax laws when preparing your self-employment tax returns.
Get Advice and Help From a Maryland Tax Attorney
According to the Social Security Administration (SSA), the rate for self-employment tax has been 15.30% since 1990. From 1988 through 1989, the rate was 15.20 percent. There does not appear to be an increase in the self-employment tax rate for the current or future tax years. However, Congress can change the tax rates by passing new tax laws, so you should always check current tax laws when preparing your self-employment tax returns.
Get Advice and Help From a Maryland Tax Attorney
As an experienced Maryland business attorney, Steve Thienel is well-versed in all aspects of business law. He assists clients in strategic tax planning to reduce their tax obligations. He also helps individuals and companies with tax compliance, tax preparation, and federal tax audits. Contact our office today to schedule a consultation to discuss reducing your tax burden.
