How to report income and pay taxes for the self employed

There are many differences between being self-employed and working for someone else. However, the taxes you owe the federal government aren’t one of them. 

If you’re self-employed, you’ll still pay the same income tax as people who earn a living in the form of a paycheck or wage paid by an employer. You’ll still owe Social Security and Medicare taxes Medicare taxes — a.k.a. FICA taxes — along with potential state income taxes depending on where you live. 

When you have your own business, no employer withholds money from your paycheck and sends it to the IRS on your behalf throughout the year. Instead, the responsibility for calculating and paying these business taxes falls squarely on your own two shoulders.

What Is Considered Self Employment Income? 

Whether you’re self-employed as a sole proprietor, an independent contractor, freelancer, or you’re part of a partnership, a member of an LLC, or shareholder in an S Corporation, the money you earn operating a trade, business, or profession may be considered self-employment income. 

As the IRS says, “If you are in business (farm or nonfarm) for yourself, you are self-employed.” Should your net earnings exceed $400 in a year, then you must report your self-employment income to the IRS and pay taxes.

This information is for educational purposes only. Please consult a CPA or tax advisor for specific questions about your tax situation.

How to Calculate Self-Employment Income

According to the IRS, if you earn more than $400 in self-employment income throughout the year, you must file a tax return. This requirement holds true regardless of any other W-2 income you bring in or your tax filing status.  

Depending on how you earn money, you can calculate self-employment income in a few different ways. 

• 1099s: Do you earn at least some of your self-employment income as an independent contractor? If so, you should receive 1099s from the companies you contract to do work for throughout the year, assuming you earned $600 or more. Be sure to keep detailed records because even if you don’t receive a 1099, you still need to report the income. Add up the total amount listed on each 1099 form plus any additional earnings from contract work and add it (or have your tax preparer add it) to your tax return.
• Gross Income: Does your business sell goods or services directly to others? If so, you will need to calculate your gross income and include it on your tax return. Gross income is the revenue you earn minus the cost of goods sold. Be sure to keep detailed records throughout the year of both your sales and expenses.  

The Self-Employment Tax Rate

When you are self-employed you’ll pay federal income taxes (and possibly state income taxes if they apply.) In addition, self-employed people also must pay self-employment tax which is a different tax than income taxes. Self-employment (or SE) tax covers Social Security and Medicare.

The current self-employment tax rate totals 15.3% — 12.4% for Social Security and 2.9% for Medicare.

For W-2 employees, the taxes due are split in half. The employee pays 7.65%, and the employer takes care of the remaining, equal portion. 

The Self-Employed Contributions Act (SECA) of 1954 requires most self-employed people to pay the full 15.3% in Social Security and Medicare taxes on their own. 

Breaking Down the Self-Employment Tax

The current 12.4% Social Security tax (6.2% X 2) is due up to a certain amount of income each year. This threshold is known as the Social Security wage base. 

• For 2023, the Social Security wage base will be $160,200.
• For 2023, the Social Security wage base will be $168,600.

For the Medicare tax, taxpayers (including self-employed filers) pay a 2.9% tax (1.45% X 2) on income, with no cap. If you earn more than $200,000 ($250,000 for married couples filing jointly, or $125,000 for married filing separately), you’ll owe an additional Medicare tax on income that exceeds those thresholds. (The Medicare surtax is currently 0.9%.)

Tax Deductions for Self Employed

As a self-employed worker, you’re not taxed on the gross income your business brings in throughout the year. (Gross income is the total before taxes or other expenses are deducted.) Rather, your tax liability is based on your net earnings.

Net earnings refers to your gross business income minus deductions the IRS allows you to claim. 

Here are some of the self-employment tax deductions you may be able to claim, potentially lowering your net income and thus reducing your tax liability. 

• Self-Employment Tax Deductions: You may reduce your net earnings by half the amount you paid in Social Security taxes. Half of your Social Security tax (the part employers typically pay for employees) may also be deducted on IRS Form 1040.
• Qualified Business Income Deduction:
• Self-Employment Tax Deductions: You may reduce your net earnings by half the amount you paid in Social Security taxes. Half of your Social Security tax (the part employers typically pay for employees) may also be deducted on IRS Form 1040.
• Qualified Business Income Deduction: Do you have a “pass-through” business (e.g., sole proprietorship, partnership, S corporation, or limited liability company)? If so, you may be able to deduct up to 20% of your qualified business income (QBI) on your taxes. QBI is your company’s profit, minus non-qualified income like dividends, capital gains or losses, income earned outside of the U.S., etc. Income caps also apply and benefits begin to phase out at more than $160,700 (single filers) or $321,400 (joint filers).
• Miscellaneous Self-Employment Deductions: Self-employed people may also qualify for other valuable tax deductions, depending on the circumstances. For example, if you work from home, you might be able to enjoy a home office tax break for a portion of your mortgage, utilities, repairs, and maintenance. Health insurance and continuing education might be tax-deductible as well. You might even be able to take advantage of tax deductions for car mileage and retirement savings. 

How to Report Self Employment Income

No matter how you earn your self-employment income, if it totals more than $400 in a year, you have to report it to the IRS. The tax form you use to report self-employment income (or loss) may vary based on the structure of your business. 

• Sole proprietors may use Schedule C Form 1040
• Farmers use Schedule F. 
• If your self-employment income comes from an S corporation, LLC, or partnership, you may need to fill out a Schedule K-1 before you file your personal taxes. 

Have questions about the specific forms you need to file with the IRS? It’s best to talk to a tax professional for personalized advice.   

How To Pay Self-Employment Tax

When you work for an employer, they withhold payroll taxes from your paycheck and make tax payments to the IRS on your behalf. When you work for yourself, you need to take care of this task. If you expect to owe a tax of $1000 or more when you file you’ll need to make quarterly estimated tax payments. 

To calculate your estimated tax, you will have to calculate your expected adjusted gross income, taxable income, taxes, deductions, and credits for the year. This is one reason why it’s important to make sure your bookkeeping is up to date, so you can calculate your quarterly estimated tax. 

The IRS provides Form 1040 ES to calculate your estimated taxes, but be warned: self-employment tax calculations can get complicated, especially if you have a spouse who works or other sources of income. Also, unlike an employee who gets paid a salary, it can be difficult for small business owners to predict their income throughout the year. 

Estimated Tax Payment Due Dates 2024

*You don’t have to make the payment due January 15, 2025, if you file your 2024 tax return by January 31, 2025, and pay the entire balance due with your return.

You can pay your tax bill online, by phone, by mail, or even in some in-person locations. You’ll find detailed payment instructions in the instructions for IRS Form 1040 ES.

You may even choose to pay with a business credit card, but there is an additional charge for credit card payments. Still, some cardholders decide it’s worth it to earn benefits, including credit card welcome bonuses. And in a serious pinch a 0% APR credit card may let you finance this tax over several months interest-free, but that shouldn’t be something you do regularly.

You will need a Social Security number or Individual Taxpayer Identification number (ITIN) to make your payments.

Some business checking accounts let you set up free sub accounts where you can set aside money for specific expenses like taxes. This can help you budget for taxes throughout the year.

Self-Employment Taxes vs. Employee Taxes

As mentioned, self-employed people usually have to pay higher Social Security and Medicare taxes. While employees pay these taxes as well, their employers split the cost with them. 

Yet some potential workarounds might help you save money on self-employment tax. It all comes down to how your business is structured. 

• S Corporation: When you elect to be taxed as an S corp, you can collect money from your business in two ways — salary and income distributions. You’ll still owe self-employment taxes on the salary portion of your income. But if you take shareholder distributions, those funds aren’t subject to SE taxes. Be aware: You have to give yourself a “reasonable” wage or you might trigger an IRS audit along with other consequences. The cost of establishing and running an S corp may be higher as well.
• C Corporation: Unlike S corporations, LLCs, and sole proprietorships, a C corporation isn’t a pass-through entity. You can avoid self-employment tax with a C corp, but your business will be subject to a corporate tax rate and possible double taxation on any shareholder dividends.
• Limited Liability Company (LLC): Your entire income is subject to self-employment tax when you form an LLC. However, you can choose to set your business up legally as an LLC, yet be taxed as an S corporation.
• Sole Proprietorship: Operating your business as a sole proprietorship is likely the easiest option available. Yet that doesn’t mean it’s the best choice. As a sole proprietor, you will undoubtedly be subject to self-employment taxes. In addition to the SE tax you must pay, a sole proprietorship doesn’t shield you from personal liability if your business is ever sued. To add insult to injury, establishing business credit scores as a sole proprietor is typically impossible. 

Self-Employment Tax: The Bottom Line

Trying to choose the right business structure and tax designation for your company can be a daunting task. You’ll need to weigh important choices like S corp vs C corp or LLC vs Sole Proprietorship. In the end, your decision will have a big impact on not just the taxes you pay, but on many other factors that affect your business as well.

It’s critical to calculate your self-employment earnings and taxes correctly. Figure your self-employment income too low, and the mistake could be expensive because penalties may apply. And if you haven’t saved money to pay those taxes, you could end up in serious trouble with the IRS, and damage your business credit scores with a tax lien. That will make it harder to get a small business loan in the future. 

Calculate your earnings too high or fail to claim all of your available tax deductions, and you might pay more than your fair share at tax time. Tax and accounting professionals  who can guide you through this process are worth their weight in gold.

Frequently asked questions about Self-Employment Tax

Do I pay both income and self-employment tax?

Often, yes. Self-employment tax covers Social Security and Medicare taxes required under the Federal Insurance Contributions Act (FICA) while federal income tax goes into the general US Treasury to cover other tax benefits.

Why is self-employment tax so high?

Self-employment taxes cover Social Security and Medicare taxes, two costly social insurance programs. Normally the employer and employee split this cost, which makes it feel less expensive to workers. Self-employed individuals cover both the employer and employee portion.

Who is exempt from self-employment tax?

Those who make less than $400 annually in self employment income, ministers, members of certain religious sects who get IRS approval to be exempt, a US Citizen employed by a federal government for services provided outside the US or its territories, you can be exempt from SE tax. Additionally,  if you and your spouse elect to be taxed as a qualified joint venture for your rental real estate business (and file the required forms), that income generally isn’t subject to SE tax.

If you had two or more businesses subject to SE tax, your net earnings from self-employment are the combined net earnings from all of your businesses. A loss in one business can reduce the income from another. Figure the combined SE tax on one Schedule SE. 

If you (or your spouse with whom you file income tax returns jointly) are paid wages, you may be able to increase your tax withholdings to cover the amount of taxes owed.

How much do you pay in taxes for self-employment?

According to the IRS, “The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for social security and 2.9% for Medicare.”

What is tax deductible for self-employed?

Self-employed individuals can deduct a range of expenses that are ordinary and necessary for their business, including the cost of using part of their home exclusively for business activities. This encompasses a portion of rent or mortgage interest, utilities, and insurance. Other common deductions include office supplies, travel expenses, and advertising costs, all aimed at reducing taxable income.

Is being self-employed worth it for taxes?

Being self-employed offers tax advantages through the ability to deduct business-related expenses, which can significantly lower taxable income. However, self-employed individuals are responsible for paying both the employer and employee portions of Social Security and Medicare taxes, which can increase tax liability. The decision often hinges on how well you can maximize deductions while managing the dual burden of self-employment taxes.

Is sole proprietor or LLC better for low taxes?

For most small businesses, the tax implications of being a sole proprietor vs. an LLC are similar since both are “pass-through” entities, meaning the business income passes through to the owner’s personal tax return. However, an LLC offers the option to be taxed as an S corporation, which could potentially lower taxes by allowing the owner to be treated as an employee and split income into salary and dividends. Ultimately, the best choice depends on your specific business income, expenses, and plans for growth, with an LLC offering more flexibility for tax planning in some scenarios.

What happens if I don’t pay my self-employment tax?

If you don’t pay your self-employment tax, you’ll likely face penalties and interest on the unpaid amount, which can accumulate quickly. Additionally, failing to pay self-employment tax can lead to an audit by the IRS, further complicating your financial situation. Over time, continued non-payment could result in the IRS taking collection actions, such as garnishing your bank accounts or placing liens on your property.

How does self-employment tax affect my Social Security and Medicare benefits?

Paying self-employment tax contributes to your Social Security and Medicare benefits, as these taxes fund your coverage under the Social Security system. The amount you pay in self-employment tax directly impacts your future benefits, with higher contributions potentially leading to higher benefits upon retirement or if you become disabled. Regularly paying self-employment tax ensures you earn credits toward Social Security eligibility, which requires a minimum number of credits to receive retirement and disability benefits, as well as Medicare coverage.

Do I report a business on my taxes if I didn’t generate any income?

Yes, you should still report your business on your taxes even if you didn’t generate any income. This is because the IRS requires all businesses to report their activities, regardless of whether they made a profit. Reporting your business activities accurately helps maintain compliance with tax laws and ensures you fulfill your tax obligations.