In many cases, workers with a strong desire for freedom, creativity, and work-life balance aren’t fans of working 9 to 5. If that’s true for you, then you belong to a group of people that constantly keeps gaining new members.
Indeed, a 2022 Upwork survey has shown freelancing to be at an all-time high, with 60 million Americans currently pursuing independent work. The appeal of freelancing largely derives from the prospects for higher income, more autonomy, and more meaningful work.
However, like most things, self-employment has its downsides, too. Without an employer, you have no regular, guaranteed income or a benefits package; you’ve also got no one to split your FICA taxes with.
In this article, we’ll give you an overview of what FICA (or self-employment) tax is, who is required to pay it, and how it can be calculated.
What is self-employment tax?
Self-employment (FICA) tax is a combination of social security and Medicare taxes that is paid in addition to income tax. Essentially, it’s the freelancer’s equivalent to the social security and Medicare taxes withheld from the income of permanent, salaried staff.
FICA, which stands for the Federal Insurance Contributions Act, provides benefits for retirees, children, and people with disabilities using the sum of the deductions from every paycheck earned.
Who has to pay self-employment tax?
Self-employed workers, the ones required to pay this tax, are defined as independent contractors or sole proprietors that report self-employed income.
According to the IRS website, you are required to pay self-employment tax if one of the two following statements applies to you:
- Your net self-employment earnings totaled $400 or more (excluding church employee income)
- You received an income of $108.28 or more as a church employee
These self-employment tax rules hold true regardless of the freelancer’s age and whether they’re receiving social security or Medicare benefits. They also apply to American citizens working abroad, as US tax obligations are determined by citizenship and not country of residence. In some cases, though, exemptions can be made for expats.
How to calculate self-employment tax
Currently, self-employment taxes have a rate of 15.3%: 12.4% for social security and 2.9% for Medicare. As mentioned previously, self-employment tax does not include any other type of tax, such as income tax.
To calculate the amount you owe as a self-employed worker, follow these steps:
Step 1: Calculate your net earnings
The very first step in calculating your self-employment tax is to work out your net earnings. To do this, you add your ordinary and necessary business expenses together and subtract the total from the gross income you earned.
Some examples of business expenses that should be deducted from your gross income include rent and utilities, staff costs, equipment, and insurance fees.
To recap, your net income is your gross income minus your business expenses.
Step 2: Calculate the amount subject to tax
Self-employment tax generally applies to 92.35% of your net earnings as a self-employed worker. If you’re wondering “why 92.35% and not 100%?”, we can explain!
This is done to achieve more fairness in the treatment of permanent, salaried employees versus self-employed professionals. As salaried employees split the 15.3% tax rate with their employers, they’re essentially paying 7.65% of their earnings in FICA taxes. When we subtract 7.65% from 100% of self-employed earnings, we’re left with 92.35%.
So, once you’ve calculated your net business income, you must multiply it by 0.9235 to see the amount that the tax will be applied to. This amount, that’s subject to self-employment tax, is also known as your taxable income.
Step 3: Apply the tax rate
As we’ve seen, the current self-employment tax rate is 15.3%. This consists of a 12.4% social security rate and a 2.9% Medicare rate. To find the amount owed in taxes, you must multiply your taxable income by 0.153.
For example, if your net income works out to $150,000, you will need to multiply it by 0.9235 first, and then multiply the result by 0.153.
Step 4: Keep in mind the amount subject to social security tax
As 12.4% of the total 15.3% self-employment tax rate goes towards your social security, you need to keep in mind that only the first $160,200 of your earnings are subject to social security tax. This is an increase of nearly 9% from the $147,000 maximum for 2022.
The maximum amount of net earnings subject to social security taxation changes every year. Stay up to date with the current tax cap by visiting the IRS website.
Step 5: Check whether you qualify for optional methods
If you experienced a loss or earned only a small amount of income, then you should take a look at the two optional methods in the IRS Schedule SE (Form 1040).
Using one of the two optional methods to calculate your net self-employed income may result in your receiving credit toward your social security. Alternatively, it may increase your earned income credit or dependent care credit.
You may be required to pay an additional Medicare tax if your earnings from self-employment are above a certain threshold. Refer to the IRS instructions for Form 8959 if you need more information.
$150,000 x 0. 9235 = $138,525
net income amount subject to tax taxable income
$138,525 x 0.153 = $21,194.33
taxable income self-employment tax amount owed
When and how to pay
All self-employed workers expecting to owe more than $1,000 in taxes are required to file an annual tax return and pay estimated taxes on a quarterly basis.
This means that, as a freelancer, you need to estimate your income and expected taxes and make four payments over the year. Typically, these payments are due on April 15, June 15, September 15, and January 15. If you’re late in making a payment, you can get penalized. Likewise, you may get penalized if you underpay. In the event that you overpay your taxes, you’ll be refunded the excess amount.
When the time comes, you can pay your self-employment tax through IRS Direct Pay, available both on desktop and mobile devices, at no additional cost. Debit and credit cards can also be used for a fee.
Starting a small business can be exciting if you don’t mind juggling several tasks at once. Of these tasks, that range from client acquisition through to business management, tax filing is often the most dreaded. This makes sense when we consider that about half of US citizens lack fundamental tax knowledge, as suggested by a NerdWallet and Harris Poll survey.
Thankfully, more and more tools are being created to simplify the tax filing process, and some are available for free.
Before you’re off to “digest” the information we shared, let’s recap the most important points in this article:
- Self-employment tax refers only to social security and Medicare taxes and is separate to income tax
- For self-employed workers, only 92.35% of net earnings are subject to self-employment tax
- The maximum amount of net income subject to social security taxation isn’t fixed
- US citizens working abroad must still pay taxes on foreign income
- For the most up-to-date, reliable information on tax deductions, exemptions, and tax bills, visit the IRS website or USA.gov portal
As a self-employed worker, what tips can you share with other freelancers to make their tax filing process easier? Write your thoughts in the comments section.