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Self-Employment Taxes Explained

If you have recently started your own small business you may have heard the term "Self-Employment Tax" crop up in conversations with your advisors.  Self-employment tax is not a new additional tax that you are required to pay because you started a business, but rather the government's way to collect Social Security and Medicare taxes for self-employed individuals.

Social Security and Medicare taxes are due on wages, tips, and net earnings from certain businesses. Self-employed individuals who report earnings on Schedule C of their individual tax return or Partners in partnerships with self-employment earnings are subject to self-employment tax.  Self-employment tax is made up of the following:

  1. Social Security tax 12.4% up to $127,200 of wages, tips, or net earnings in 2017.
  2. Medicare tax 2.9%
  3. Additional Medicare tax .9% this tax is only calculated for taxpayers whose wages, tips, and net earnings (including spouses) exceed certain thresholds depending on filing status. Currently the threshold is $200,000 for Single filers and $250,000 for Married Filing Joint filers.

Net earnings under $400 are not subject to self-employment tax.

As an employee who receives a Form W-2 wage reporting statement you may have noticed that Social Security and Medicare are withheld from your wages to get to your net check and are reported on your W-2.  The amount that is deducted from your pay is only half of the total tax due, your employer pays the other half.  When you are self-employed, the entire burden resides with you.  However, there is a deduction from the total income on your individual tax return that is equal to the employer equivalent or about half of the total self-employment tax. This deduction only affects your income tax and does not affect either your net earnings from self-employment or self-employment tax.

Most self-employed individuals are required to pay estimates throughout the year to pay the self-employment and income tax due on their earnings.  For a full discussion on estimates see our article. It is important to remember self-employment tax when saving for your overall tax liability as the numbers can change dramatically if not considered.  There are different ways of limiting your self-employment tax liability based on entity structure, retirement options, and expense planning.  For guidance on how to reduce your liability based on your individual situation please contact your tax advisor.

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