What is Self-Employment Tax?
Self-employment tax is a specific tax that applies to individuals who earn income through self-employment. This tax primarily covers Social Security and Medicare taxes, which are typically withheld from wages by employers. Self-employed individuals, however, are responsible for paying this tax themselves.
As a self-employed person, you are required to pay both the employer and employee portions of these taxes. This translates to a total self-employment tax rate of 15.3%. It consists of 12.4% for Social Security and 2.9% for Medicare. For income exceeding a certain threshold, an additional 0.9% Medicare tax may also apply.
Self-employment tax applies to various forms of income, including freelance work, contract work, and business profits. Importantly, even if you operate at a loss for the year, you may still be required to pay self-employment tax if you earn a certain minimum amount.
To report self-employment tax, individuals typically use Schedule SE when filing their tax returns. It’s crucial for self-employed individuals to set aside funds to cover this tax, as underpayment can lead to penalties and interest charges from the IRS.
Understanding self-employment tax is essential for financial planning and compliance with tax obligations, ensuring that self-employed individuals are adequately prepared for their tax liabilities.