What is gross income? How it works and why it’s important
A person’s gross income is used to determine how much they have to pay toward federal and state income taxes.
3 MIN READ
Jun. 2, 2021
What is self-employment tax?
In addition to income tax, people who work for themselves are obliged to pay Social Security and Medicare taxes, which together comprise the self-employment tax. This tax is equivalent to the Federal Insurance Contributions Act (FICA) tax withheld by employers from their workers’ earnings.
Deeper definition
As of 2017, the Social Security tax rate is 12.4 percent, and the Medicare tax rate is 2.9 percent. Employers and employees each pay one half of the tax. Self-employed individuals must pay the full amount, 15.3 percent. They also may deduct the equivalent of the employer contribution to reduce the adjusted gross income used to calculate their tax liability. This tax only applies to the first $118,500 of income. Individuals pay a 2.9 percent rate on income over that threshold.
The Internal Revenue Service (IRS) defines self-employed workers as:
- Sole proprietors who own unincorporated businesses.
- Independent contractors who work in a trade, business, or profession in which they control the result of their work, including doctors, lawyers, accountants, contractors, and subcontractors.
- Members of partnerships who engage in trade or business and have not incorporated the partnership or formed an LLC.
These categories apply to all individuals who work for themselves and earn a profit, regardless of the number of hours they work. Even part-time work qualifies as self-employment if workers earn money themselves instead of receiving payment from an organization.
Individuals who work for themselves as sole proprietors or independent contractors and have a net income of more than $400 must pay self-employment taxes. Additionally, church employees who earn more than $108.28 also pay self-employment taxes. Retirees who are currently drawing Social Security and Medicare benefits must pay self-employment taxes if they earn a qualifying income.
Self-employment tax example
An independent contractor who earns $150,000 during the tax year must pay $18,130 for payroll taxes, $14,694 toward Social Security and $3,436 toward Medicare. In addition, the contractor pays $914 to cover the portion of income over the $118,500 threshold. If this individual worked for an employer, the employer would pay half of the payroll taxes, leaving the taxpayer an obligation of $9,065.
