Self-employed individuals pay federal income tax through quarterly estimated tax payments based on their business profits, reported annually via Schedule C.
Unlike employees who have taxes withheld from their paychecks, self-employed people must calculate and pay their own taxes. The IRS requires four estimated tax payments per year, typically due April 15, June 15, September 15, and January 15 of the following year. These payments cover both income tax and self-employment tax, which funds Social Security and Medicare.
Self-employment tax equals 15.3% of net earnings (92.35% of self-employment income). The rate consists of 12.4% for Social Security and 2.9% for Medicare. In 2023, the first $160,200 of earnings is subject to the Social Security portion. Earnings above $200,000 ($250,000 for married filing jointly) incur an additional 0.9% Medicare tax.
Self-employment income includes earnings from freelancing, consulting, gig work, and running a small business. Common sources are:
To calculate federal income tax, subtract business expenses from gross income using IRS Schedule C. The result is net profit, subject to income tax and self-employment tax.
For example, if a freelance writer earns $50,000 and has $10,000 in expenses, their net profit is $40,000. They'd owe approximately $4,600 in income tax (assuming a 22% effective rate) plus $6,120 in self-employment tax (15.3% of $40,000), totaling $10,720.
Self-employed individuals must make quarterly estimated tax payments using IRS Form 1040-ES. Payments are based on the previous year's tax liability or current year's expected earnings. Underpayment penalties apply if payments are insufficient.
Many self-employed people confuse income tax with self-employment tax. While income tax rates range from 10% to 37%, self-employment tax is a flat 15.3%., some believe only W-2 employees pay Social Security and Medicare taxes, but self-employed individuals fund these programs through self-employment tax.
Another misconception is that self-employed individuals don't qualify for retirement plans. However, they can contribute to SEP IRAs, Solo 401(k)s, and SIMPLE IRAs, reducing taxable income while saving for retirement.
Self-employed individuals can lower their tax burden by deducting business expenses, contributing to retirement accounts, and claiming the self-employed health insurance deduction. Structuring a business as an S corporation may also reduce self-employment tax liability by paying reasonable salaries.
For instance, a consultant earning $100,000 could form an S corporation, pay themselves a $50,000 salary, and distribute the remaining $50,000 as dividends. This reduces self-employment tax to 15.3% of $50,000 instead of $100,000.
Understanding federal income tax for self-employed individuals ensures compliance and financial planning. For more details, visit the IRS website or consult a tax professional.