Self-employment taxes are the same as payroll taxes for the self-employed and it is used fund Social Security and Medicare. All individuals with self-employment income must pay self-employment taxes, regardless of their age. The self-employment tax is paid on your net earnings from self-employment, not your entire business income.
In this article, we will discuss:
- How Much Are Self-Employment Taxes?
- Who Is Subject to Self-Employment Taxes?
- Which Income Is Not Subject to Self-Employment Taxes?
How Much Are Self-Employment Taxes?
Self-employment taxes are not a small thing and you as the business owner need to be aware of its impact in your total tax liability. You will be surprised to know that many business owners pay more in self-employment taxes than income taxes.
There are two components to the self-employment tax:
- a 12.4 percent Social Security tax up to an annual income ceiling adjusted for inflation each year ($147,000 for 2022), and
- a 2.9 percent Medicare tax on all net earnings from self-employment.
There is a possible third component:
If your net earnings from self-employment are over $200,000 if you’re single, or $250,000 if you’re married filing jointly, you must pay a 0.9 percent additional Medicare tax on net earnings from self-employment over the $200,000 threshold, for a total 3.8 percent Medicare tax. (IRC Section 1401)
Who is Subject to Self-Employment Tax?
You pay self-employment tax if you:
- earn income on a 1099,
- operate as a single-member LLC,
- do business as a sole proprietor,
- are a general partner in a partnership,
- are an LLC member in a multi-member LLC, or
- are a co-owner of any other business entity taxed as a partnership. (There is an exemption for limited partners)
You don’t pay self-employment taxes on personal investment income or hobby income. For example, you don’t pay self-employment taxes on profits you earn from selling stock, your home, or an occasional item on eBay.
Tax Tip: The self-employment tax is not a progressive tax. It starts immediately—on dollar one, once you have over $433 in Schedule C, E, or F net income from a business ($433 x 92.35 percent = $400, the trigger number for Schedule SE). Your net earnings from self-employment start with the gross income from your trade or business minus deductions attributable to the business. This makes business deductions doubly valuable since they reduce both your income and self- employment taxes. In contrast, personal itemized deductions and “above-the-line” adjustments to income don’t decrease net earnings from self-employment.
Which Income Is Not Subject to Self-Employment Taxes?
- Rental Income (With Two Exceptions) – In general, rental income is not considered self-employment income and is not subject to self-employment taxes unless it is received as part of a real estate dealer’s trade or business. (IRC Section 1402(a)(1))
- Rental income from equipment leasing
- Services for tenants can trigger self-employment taxes – services are considered rendered to the occupant if they are primarily for his convenience and are other than those usually or customarily rendered in connection with the rental of rooms or other space for occupancy only. For example, the supplying of maid service, constitutes such service; whereas the furnishing of heat and light, the cleaning of public entrances, exits, stairways and lobbies, the collection of trash, and so forth, are not considered as services rendered to the occupant.
- Rents from personal property leased with rental real estate, such as kitchen appliances, are also not self-employment income.
- Most Interest Income Is Not Self-Employment Income, with the exception of interest received in the course of a trade or business is subject to such taxes. (Reg. Section 1.1402(a)-5)
- Most Dividends Are Not Self-Employment Income, unless the recipient is a dealer in securities who receives the dividends in the course of the dealer’s business.
- Gain or Loss from Business Property Is Not Self-Employment Income.
- You don’t include in net earnings from self-employment gain or loss from the sale or exchange of a capital asset, or the sale, exchange, involuntary conversion, or other disposition of property unless it is inventory.
- Distributions from S Corporations.
Here are four things to know from this article:
- The self-employed must pay a 12.4 percent Social Security tax and a 2.9 to 3.8 percent Medicare tax on their net earnings from self-employment.
- You must pay self-employment taxes if you earn income from a business that you report on Schedule C or F, co-own as a general partner in a partnership, or own as a member in a multi- member LLC, or if you co-own any other business entity taxed as a partnership.
- Net earnings from self-employment do not include real estate rental income (unless you provide services to tenants), dividend or interest income, or gain or loss from business property other than inventory.
- Distributions from S corporations are not subject to self-employment taxes.