A self-employment tax guide for small business owners
Small business owners have many responsibilities, but one that is of a high priority is how to manage taxes, which is the key to optimizing their financial situation on both a personal and business level. I help my small business owner clients in this area of managing their overall taxes. However, this blog post specifically addresses self-employment taxes and is a guide to help small business owners understand the essentials of these taxes.
What are self-employment taxes?
Per the IRS, “Self-employment tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves.” Generally, net earnings from self-employment (for self-employed individuals who are sole proprietors, Schedule C (Form 1040) is generally used to figure net earnings from self-employment) are subject to self-employment tax. Self-employed individuals are responsible for calculating and paying these self-employment taxes themselves using Schedule SE (Form 1040). These taxes fund the Social Security (old-age, survivors, and disability insurance) and Medicare (hospital insurance) programs. The Self-Employed Contributions Act (SECA) requires self-employed individuals to pay both the employer and employee portions of the Social Security and Medicare taxes, which ensures they are covered by these social safety programs.
Social Security: current tax rate for employer is 6.2% and current tax rate for employee is 6.2%.
Medicare: current tax rate for employer is 1.45% and current tax rate for employee is 1.45%.
As a result, self-employed individuals are responsible to pay the combined rate of 12.4% for Social Security taxes and combined rate of 2.9% for Medicare taxes, which adds up to 15.3% for self-employment taxes. Note that self-employed individuals can deduct the employer-equivalent portion of their self-employment tax in figuring adjusted gross income. Also note that there is a maximum earnings amount ($168,600 for the 2024 tax year) that is subject to Social Security tax. In other words, earnings above this amount are not subject to Social Security tax. Regarding Medicare, all earnings are subject to Medicare tax. There is an additional Medicare tax of 0.9% on earnings over $200,000 ($250,000 for married filing jointly).
Self-employment tax payments
Since self-employed individuals do not have taxes withheld from paychecks like traditional employees, estimated tax payments are due throughout the year. These payments cover both income tax and self-employment tax. Payments are due quarterly: April 15 (for income earned from 1/1 to 3/31), June 15 (for income earned from 4/1 to 5/31), September 15 (for income earned from 6/1 to 8/31), and January 15 of the following year (for income earned from 9/1 to 12/31). Note that these due dates do not coincide with regular calendar quarters.
Per the IRS, “You may send estimated tax payments with Form 1040-ES by mail, or you can pay online, by phone or from your mobile device using the IRS2Go app. You can also make your estimated tax payments through your online account, where you can see your payment history and other tax records. Go to IRS.gov/account. Visit IRS.gov/payments to view all the options. For additional information, refer to Publication 505, Tax Withholding and Estimated Tax.”
The underpayment of estimated tax could result in penalties and interest imposed by tax authorities. Tax authorities (IRS and your individual state) have these types of penalties and interest in place because they are ultimately trying to get tax payments made to them accurately and in a timely manner. It is prudent for a small business owner to be proactive and stay ahead of their tax obligations to make sure they are not in a situation where they owe penalties and interest, which are detrimental to the overall cash flow of their business.
Self-employment health insurance tax deduction
It is important to note that a tax deduction is allowed to self-employed individuals for the cost of health insurance (e.g., health insurance premiums for medical and dental coverage). Self-employed individuals can deduct up to 100% of the health insurance premiums that they paid during the year, which helps to offset the cost of health insurance coverage. Coverage that is included in this self-employed health insurance deduction includes premiums paid for self-employed individuals, their spouse, and their dependents. Note that access to participation in an employer-sponsored subsidized health plan would make the self-employed individual ineligible for this deduction. I illustrate this ineligibility with a hypothetical example below.
Mike has been self-employed for 7 years as a website designer. He and his wife, Dana, have been married for 13 years and have two children. Mike and Dana decided that the most economical way to obtain health insurance for their family is through Dana’s employer, which provides Dana an employer-sponsored subsidized health plan as a benefit. They decide to take advantage of this benefit offered by Dana’s employer, which means that Mike has access to participation in an employer-sponsored subsidized health plan making him ineligible for the self-employment health insurance tax deduction.