Self-employment tax: what it is, how it works and how you can save

Does self-employment tax apply to you? How much tax do you pay on your income? Are there other tax benefits to owning your own business? Let EY TaxChat™ prepare your individual income tax return this year and report your self-employment income.

In brief

• Being self-employed could mean paying 15.3% self-employment tax
• Be sure to make quarterly estimated tax payments to avoid underpayment penalties and interest
• Saving for retirement and the tax benefits of those savings are still available for self-employed taxpayers 
• Need guidance? Let EY TaxChat™ help prepare your tax return this year

Am I considered self-employed and does the tax apply to me?

If you own your own business, or with others as a partner in a partnership, work as an independent contractor or as a freelancer, you are generally considered self-employed, where your income is subject to self-employment tax. Further, in the current “gig economy” landscape, those “side-hustle” earnings may be subject to self-employment tax as well.

What is self-employment tax?

It’s a federal tax, consisting of Social Security and Medicare taxes that applies to self-employed individuals. Employees don’t get a freebie — they are required to pay their share of Social Security and Medicare taxes, too. Employees pay their portion via payroll withholdings, whereas self-employed individuals are responsible for paying their taxes, typically as part of quarterly estimated tax payments throughout the year.

How much self-employment tax do I have to pay?

Self-employment tax is comprised of Social Security and Medicare taxes. This tax amount is in addition to your other income taxes assessed on the net income from your business. Social Security is equal to 12.4% on the first $147,000 of earnings in 2022, while Medicare is equal to 2.9% on unlimited earnings. Therefore, the combined total self-employment tax may be as high as 15.3%. As a basic example, if you have net self-employed earnings of $ 147,000 in 2022, your self-employment tax would be $22,491.

Tax benefits available to self-employed taxpayers

There are various deductions and tax-savings opportunities for those who are self-employed. Self-employed individuals are entitled to a deduction of 50% of their self-employment tax on their individual income tax return. Self-employed individuals may also be able to deduct items such as health care premiums and certain qualified business expenses. Recent tax law also introduced the qualified business income deduction (QBI), a tax deduction that allows eligible self-employed and small business owners to deduct up to 20% of their qualified business income on their taxes.

How do I actually pay my taxes now that I am self-employed?

Estimated tax payments! With the freedom of being your own boss comes the responsibility of paying your own taxes. Unlike employees, who generally have their income tax and payroll taxes withheld through their wages, self-employed individuals generally must pay estimated taxes on a quarterly basis. Failure to pay the correct amount of estimated tax throughout the year can result in underpayment penalties and interest. Review IRS Estimated Taxes for more information.

Retirement options available to self-employed taxpayers

Solo 401(k)

This is an individual 401(k) designed for a business owner with no employees. This plan allows an individual the ability to contribute up to $61,000 in 2022 (plus $6,500 catch-up contributions for those 50 or older) or 100% of earned income, whichever is less. Your contributions are a pre-tax benefit, and distributions upon retiring (after age 59½) are taxed.

SEP IRA

This is an IRA available to self-employed taxpayers that has gained popularity due to ease and increased benefits. Many institutions now offer help to establish and administer these plans. Self-employed individuals can make larger contributions of the lesser of $61,000 or up to 25% of net self-employment earnings for 2022. Qualified contributions to a SEP IRA are deductible on your individual income tax return and later taxable once you withdraw.

Simple IRA

This is an alternative to a traditional IRA, with many of the same characteristics: the ability to contribute up to $14,000 in 2022 (plus catch-up contribution of $3,000 if 50 or older). For those who also contribute to an employer-sponsored plan, the total of all contributions can’t exceed $19,500. Contributions may be deductible, but distributions when you retire (or age 59½) are taxed.

Defined benefit plan

This is quite different from the other retirement plan options, with a bit more complexity to establish. The contributions to be made are calculated based on the benefit you’ll receive at retirement, your age and expected investment returns, but no more than $245,000 for 2022. Contributions are generally tax deductible, and distributions in retirement are taxed as ordinary income. An actuary must figure your deduction limit, which adds an administrative layer.

About EY TaxChat™

EY TaxChat is an on-demand mobile service that connects you with a licensed tax professional who will prepare your taxes and file them for you. Click here to learn more and register for EY TaxChat at any time, from anywhere, or by downloading the app from the Apple App Store or GooglePlay Store.