In a NutshellIt can be easy for freelancers and self-employed people to forget about taxes because no employer is automatically deducting tax from your paycheck. But if you want to avoid IRS penalties, you’ll need to get comfortable calculating and estimating self-employment taxes.
This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma.
If you’re new to self-employment, estimating and paying self-employment taxes might seem scary.
But you need to face your fear and get a handle on self-employment taxes if you want to avoid IRS penalties.
If you recently made the leap from employee to freelancer, independent contractor or business owner, dealing with taxes — especially self-employment tax — may feel overwhelming. As an employee, your employer withheld and paid federal and state income tax and payroll taxes on your behalf. As a self-employed person, you’re on your own.
If this is your first time paying self-employment taxes, this guide will help you figure out how to estimate what you’ll owe and pay it on time.
- What is self-employment tax?
- How much are self-employment taxes?
- When do I have to pay self-employment tax?
- What happens if I don’t pay self-employment tax on time?
What is self-employment tax?
If you’ve ever prepared a federal income tax return, you’re probably at least somewhat familiar with income taxes. But self-employment taxes are something else entirely.
If you remember back to the paystubs you received from your employer, you may have noticed the employer withheld several different amounts from your gross pay, including Social Security and Medicare taxes. Virtually everyone who works must pay those taxes. Self-employment tax is the equivalent of the Social Security and Medicare taxes, but for people who work for themselves.
The IRS considers you to be self-employed if you are a freelancer, an independent contractor or in business for yourself, either alone or as part of a partnership. If you had self-employment income earnings of $400 or more during the year, you are required to pay self-employment taxes and file Schedule SE with your Form 1040.
How much are self-employment taxes?
Self-employment taxes consist of two separate rates: 12.4% for Social Security and 2.9% for Medicare, for a combined rate of 15.3%.
When you’re an employee, your employer withholds half (6.2% Social Security and 1.45% Medicare) from your paycheck and matches those amounts for a total of 15.3%. When you are self-employed, you are responsible for the whole 15.3%.
However, you can deduct half of your self-employment tax as an adjustment to gross income — that’s the amount your employer would pay if you worked for someone else as an employee. On the your Form 1040, you’ll claim this deduction on Line 27 of Schedule 1.
But calculating your estimated self-employment tax isn’t as simple as multiplying your self-employment earnings by 15.3%. Two factors make the calculation a little more complex: The Social Security wage base and the additional Medicare tax for high-income earners.
Social Security wage base
Social Security taxes are only charged on a portion of your income. This is called the Social Security wage base. For 2018, the Social Security tax applies to the first $128,400 of your combined income from wages and self-employment.
For example, say you have a full-time job earning $75,000 per year and drive for Uber on the weekends, making an additional $20,000 for the year. Your employer withholds 6.2% Social Security tax on your wages and matches another 6.2%. Your combined earnings from your job and your side gig are less than the Social Security wage base of $128,400, so you’ll pay another 12.4% on your ride-share driving income of $20,000.
However, if your earnings from your full-time job were $130,000, then you would have the maximum Social Security tax withheld from your wages. In that case, any self-employment income earned with your side gig would not be subject to the Social Security portion of self-employment taxes.
There is no wage base for Medicare, so no matter how much you earn, all wages and self-employment income are subject to Medicare tax.
Additional Medicare tax
In addition to the 2.9% Medicare tax mentioned above, high-income earners are responsible for paying an Additional Medicare Tax of 0.9% on income above the following thresholds:
When do I have to pay self-employment tax?
Your federal income tax return for any year is generally due on April 15 of the following tax year. However, because you’re self-employed, you may need to make quarterly estimated tax payments to cover both your income tax and your self-employment tax obligations.
If you must make estimated quarterly payments, they’re due on April 15, June 15, Sept. 15 and Jan. 15 of the following year. Those due dates shift to the following business day if the 15th falls on a weekend or holiday. And special rules may apply if you’re not a fiscal year taxpayer whose tax year doesn’t begin on January 1, or if you’re a farmer or fisherman.
If this is your first time dealing with self-employment taxes, knowing how much you should pay can be confusing.
The IRS provides a worksheet on Page 7 of Form 1040-ES to help you calculate your estimated self-employment tax, as well as your deduction for half of your self-employment taxes. You can use this worksheet and the worksheet on Page 8 of Form 1040-ES to calculate both your estimated self-employment tax and estimated income tax for the year. Divide them by four, then pay them in four equal installments by the due dates mentioned above, using the vouchers included in Form 1040-ES.
What happens if I don’t pay self-employment tax on time?
If you estimate that you’ll owe at least $1,000 in tax for the year and don’t pay your self-employment tax on time (or at all), you could end up owing a penalty for underpayment of estimated tax or if you pay your estimated taxes late. This is true even if you are due a refund when you file your return.
The IRS calculates your underpayment penalty by figuring out how much you should have paid for each of the four quarterly installments, then multiplying the difference between what you paid and what you should have paid by the effective interest rate for the period. The effective interest rate is set quarterly. For the third quarter of 2018, the effective interest rate for underpayments is 5%.
The penalty is calculated separately for each installment due date, so you can be charged a penalty for one quarter but not the others.
If this is your first foray into self-employment, you may have no idea how much you’ll earn, so trying to figure out how much self-employment tax you’ll end up owing will be tough. You may want to consult a tax professional who can help you make an educated estimation.
If you end up making more than you thought, you can increase your estimated payments later in the year to reduce your potential penalties. If you end up making less, you can reduce your quarterly estimates later in the year, or apply the overpayment to next year’s estimated payments, thereby lowering the amount you’ll need to pay next year.
Without an employer to calculate and withhold taxes on your behalf, you’ll have to do the calculations on your own. But paying self-employment taxes is an important part of being your own boss.
A senior product specialist with Credit Karma, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.