Understanding Self-Employed Taxes

Self-employment brings financial freedom, but it also means handling taxes differently than traditional employees. When you work for yourself, you're responsible for calculating, reporting, and paying taxes that would normally be handled by an employer.

This guide explains how self-employed taxes explained works, covering what makes taxes for self-employed individuals different from those of employees.

What Makes Self-Employment Taxes Different

The most significant difference is that self-employed individuals pay both the employee and employer portions of Social Security and Medicare taxes.

When you work for a company, your employer withholds these taxes from your paycheck and matches your contribution. As a self-employed person, you pay both portions yourself through self-employment tax.

Self-employment tax is separate from income tax, though both are calculated on the same return. You pay income tax on your net earnings (income minus expenses) and self-employment tax on those same earnings.

There's no automatic withholding when you're self-employed. Instead, you're responsible for estimating and paying taxes quarterly throughout the year.

How Self-Employment Tax Works

Self-employment tax covers your Social Security and Medicare contributions, often referred to collectively as FICA taxes when you're an employee.

The self-employment tax rate consists of two parts:

• Social Security tax on earnings up to a certain annual cap

• Medicare tax on all net earnings, with no cap

Together, these taxes are significantly higher than what employees see withheld from their paychecks because self-employed individuals pay both the employee and employer portions.

Not all self-employment income is subject to this tax. You calculate it based on net self-employment earnings, which is your income minus allowable business expenses.

There's a small adjustment that reduces the amount subject to self-employment tax, which accounts for the employer portion that employees don't pay tax on.

Income Tax for Self-Employed Individuals

In addition to self-employment tax, you also pay regular income tax on your net earnings.

Your net earnings are calculated by subtracting business expenses from your gross income. These expenses might include:

• Office supplies and equipment

• Business-related travel and meals

• Professional services like accounting or legal fees

• Home office expenses if you qualify

• Health insurance premiums for self-employed individuals

• Retirement plan contributions

The income tax you pay is based on your total taxable income, which includes self-employment earnings plus any other income sources, minus deductions.

Self-employed individuals can take the standard deduction or itemize, just like employees. Additionally, there are specific deductions available only to self-employed people, such as the deduction for half of self-employment tax paid.

Quarterly Estimated Tax Payments

Unlike employees who have taxes withheld from each paycheck, self-employed individuals must pay estimated taxes quarterly.

These payments cover both income tax and self-employment tax. The IRS expects you to pay taxes as you earn income throughout the year, not in one lump sum when you file your annual return.

Estimated payments are typically due four times per year, spread roughly evenly across the calendar. Missing these payments or underpaying can result in penalties and interest charges.

The amount you pay each quarter is based on your expected annual income. If your income fluctuates, you may need to adjust your estimates throughout the year to avoid underpayment penalties.

Some self-employed individuals find it helpful to set aside a percentage of each payment they receive to cover their tax obligations, though this isn't required by the IRS.

Business Deductions and Expenses

One advantage of self-employment is the ability to deduct ordinary and necessary business expenses, which reduces your taxable income.

Ordinary expenses are common and accepted in your industry. Necessary expenses are helpful and appropriate for your business, though not necessarily indispensable.

Common deductible expenses include:

• Cost of goods sold for product-based businesses

• Marketing and advertising costs

• Professional development and education related to your business

• Business insurance premiums

• Software subscriptions and technology

• Supplies and materials

The home office deduction is available if you use part of your home exclusively and regularly for business. This can include a portion of rent or mortgage interest, utilities, and maintenance costs.

Vehicle expenses can be deducted if you use your car for business, either by tracking actual expenses or using the standard mileage rate.

Record-keeping is essential. You need documentation to support your deductions—receipts, invoices, mileage logs, and bank statements all serve as proof if questioned.

How Business Structure Affects Your Taxes

The way you structure your business changes how you're taxed and what forms you file.

Sole proprietors report business income and expenses on Schedule C of their personal tax return. This is the simplest structure and most common for freelancers and independent contractors.

Partnerships file an informational return, but the income flows through to partners who report it on their individual returns. Each partner pays self-employment tax on their share of partnership income.

LLCs can be taxed as sole proprietorships (single-member), partnerships (multi-member), or corporations, depending on how they elect to be treated.

S Corporations allow owners to pay themselves a reasonable salary (subject to payroll taxes) and take additional profits as distributions (not subject to self-employment tax). However, this structure comes with additional administrative requirements and costs.

C Corporations are separate tax entities that pay corporate income tax. Owners pay personal income tax only on salaries and dividends received.

The choice of structure affects not just taxes but also liability protection, administrative burden, and long-term flexibility.

Filing Requirements and Forms

Self-employed individuals typically need to file additional forms beyond the standard Form 1040.

Schedule C is where sole proprietors report business income and expenses. This form calculates your net profit or loss, which then flows to your main tax return.

Schedule SE calculates your self-employment tax based on your net earnings from self-employment.

If you have employees, you'll also need to file employment tax returns and handle payroll withholding, which adds another layer of complexity.

Those who pay estimated taxes use Form 1040-ES to calculate and submit quarterly payments.

State requirements vary, but most states with income tax require self-employed individuals to file state returns and may have their own estimated payment requirements.

Common Misconceptions About Self-Employment Taxes

Several myths about self-employment taxes create confusion.

"I don't need to pay taxes if I make under a certain amount" — Actually, the threshold for self-employment tax is quite low. If you have net earnings above a few hundred dollars, you're required to pay self-employment tax and file a return.

"I can deduct anything related to my work" — Deductions must be both ordinary and necessary. Personal expenses, even if they indirectly benefit your work, generally aren't deductible.

"Quarterly payments are optional" — They're required if you expect to owe a certain amount in taxes. Skipping them results in penalties, even if you pay the full amount when you file your annual return.

"Being an independent contractor means I'm not responsible for taxes" — The business that pays you isn't withholding taxes, which means you're fully responsible for calculating and paying both income and self-employment taxes.

Understanding these realities helps prevent costly mistakes and surprises.

If you need help understanding how self-employment tax applies to your specific work situation, Zoila Tax is available to walk through the details with you.