From Uber drivers to graphic designers, more and more people earn at least some of their income as independent contractors or freelancers, making them self-employed in the eyes of the IRS. If you earn more than $400 a year from self-employment, you'll need to file a federal tax return on that income.
For those new to the self-employment game, the tax implications can seem daunting, but they don't need to be. The main thing to understand is what the IRS means by "self-employment tax."
The 15.3% self-employment tax rate includes two components:
- 12.4% Social Security tax on income up to $118,500 (this cap often changes from year to year)
- 2.9% Medicare tax on all income
If you've worked for an employer, you've probably seen Social Security and Medicare taxes withheld on your paycheck - a total of 7.65% of your income. What you usually don't see on these paychecks is the other 7.65% your employer pays for you.
Put another way, employers and employees split the Social Security and Medicare taxes on income earned by employees. But when you're self-employed, you take on the roles of both employer and employee and pay the full 15.3% tax rate on your income.
The IRS may call it the "self-employment tax," but it's really the same Social Security and Medicare tax other wage earners are also paying.
If you're worried about shouldering the extra tax burden from self-employment earnings, remember that it's not all doom and gloom: there are plenty of potential tax benefits to self-employment as well. An experienced accountant or tax attorney can help you understand your options and minimize your tax liability.