Self-employed people, small business owners, or freelancers pay self-employment tax. You may need to know why your pay is not the same as the announced salary; the reason behind it is a payroll tax.

If you want to know what income tax is and how to calculate it, read the article below! This article will provide a complete guide about income tax and how to pay it.

What is Self Employment Tax?

Self-employment tax, or SECA tax (Self-employment Contributions Act Tax), is a financial responsibility to self-employed individuals, business owners, or freelancers.

It was introduced in 1954 through the SECA, ensuring self-employed individuals contribute to social security and Medicare. The self-employment tax is 15.3 %, including 12.4 % for Social Security and 2.9% for Medicare.

Most people mix the terms payroll tax and self-employment tax, while there’s a big difference between both. The employers and employees collectively pay the Social Security and Medicare taxes (7.65%), while self-employed individuals spend their 15.3% SE alone.

This tax applies to persons with net earnings exceeding $400, and it’s crucial for funding vital government programs. Calculated using IRS form 1040 Schedule SE, it emphasizes the responsibility of self-employed individuals to maintain contributions for Social Security, and Medicare.

What are Self-Employment Tax Rates?

The self-employment tax is 15.3% of your annual earnings. When we talk about the FICA tax rate, it is the same as 15.3% (7.65 employer text + 7.65 employee tax); from this, 7.65 the 6.2 is contributed for Social Security and 1.45% for Medicare from both portions.

The SE 15.3% broke down into 12.4% Social Security tax for supporting old-age and disability insurance, while 2.9% goes down for hospital insurance. Understanding these rates is crucial due to the Social Security wage base.

Until your earnings pass the specific point set as $168,600 for 2024, you will pay 12.4% of the Social Security portion. Once your earnings exceed this point, you no longer contribute to the social security portion.

Moreover, a 0.9% Medicare tax will increase if your earnings exceed the set limit. For example, the limit for singles is $200,000. Beyond this point, the Medicare tax rate will increase by 0.9% (2.9 + 0.9% = 3.8%).

The earning limit depends on your filing status.

• Single - $200,000
• Married filing together - $250,000
• Marries filing separately - $125,000
• Head of household with supporter - $200,000
• Qualifying Widow with dependent child - $ 200,000

How Do You Calculate the Self-Employment Tax?

Calculating the self-employment tax is crucial for financial planning. Firstly, determine your net earnings by subtracting business expenses from your yearly income. Generally, 92.35% of these net earnings are subjected to self-employment tax. However, remember the Social Security portion's net earning limit of $168,200 for 2024.

For a social security portion, apply a 12.4% tax on earnings up to the limit and nothing beyond that. At the same time, the second portion contributes to Medicare at a 2.9% rate for all earnings. You must pay 0.9% more Medicare tax if your income exceeds the mentioned limit.

Another simplified way for calculating self-employment tax is to multiply your wage by 15.3%. Once earnings surpass the Social Security wage base, switch to multiplying only the amount that exceeds the base by 2.9%. If your earning exceeds the limits, e.g., $200,000, include the additional medicare tax by multiplying the amount beyond $200,000 by 3.8%.

How Do You Pay a Self Employment Tax?

The most important question that comes to mind is how to pay the self-employment tax. Firstly, use the IRS Schedule C to calculate your net earnings from self-employment.

After that, use an IRS Schedule SE tool to determine how much self-employment tax you owe. Provide your Social Security number or Individual Tax Payer Identification Number (ITIN) while making payments.

Consider making quarterly estimated tax payments throughout the year if you owe at least $1000 in Federal Income Tax even after accounting for withholding and credits. Ensure your credits cover at least 90% of the current tax liability or 100% of the previous year’s liability, with a higher outset for higher income.

You can use online, phone, money/order using the estimated tax payment voucher for payment. Use form 1040-ES, Estimated Tax for Individuals, to determine your liability and facilitate timely payments.

Conclusion

You have to pay the self-employment tax if you are earning above the thresholds on which tax is applicable. However, you can get deductions in your self-employment tax that can give you a bit of relief.

You may also get relief if you are working with the employer, as your income will pay half of the tax. You can manage your taxes more appropriately if you know the correct procedure and the amount of tax you owe. You can also consult a finance expert to take advice.

FAQs

What is the difference between being self-employed and being a freelancer?

Self-employed people work on projects with a physical presence for themselves, while freelancers primarily work for their clients from virtual offices. They mostly get paid from task to task. Freelancers usually work alone or can build virtual teams for work.

What is the self-employment tax in Pakistan?

Tax rates in Pakistan can vary depending on your income. However, you must pay Self-Employment tax from 0-35% as it resonates with your annual income. However, you are charged the nominal professional fee of around $2 each year.

What is self-employed income?

Self-employment is an income that you generate by selling your services. You can earn a self-employed income through small businesses, freelancing, or working independently. Self-employed workers manage their business activities, set tier service prices, and handle their taxes.