If you own an unincorporated business, you likely pay at least three different federal taxes. In addition to federal income taxes, you must pay Social Security and Medicare taxes, also called the self-employment tax. You pay the self-employment tax if you earn income from a business you own as a sole proprietor, a single-member LLC, or co-own as a general partner in a partnership, an LLC member, or a partner in any other business entity taxed as a partnership. There is an exemption for limited partners.
You don’t pay self-employment tax on personal investment income or hobby income. For example, you don’t pay self-employment tax on profits you earn from selling stock, your home, or an occasional item on eBay.
Self-employment taxes are not insubstantial. Indeed, many business owners pay more in self-employment taxes than in income tax. The self-employment tax consists of:
- a 12.4 percent Social Security tax up to an annual income ceiling of $147,000 for 2022
- a 2.9 percent Medicare tax on all self-employment income
These amount to a 15.3 percent tax, up to the $147,000 Social Security tax ceiling. If your self-employment income is more than $200,000 and you are single, or over $250,000 if you are married, you must pay an additional 0.9 percent Medicare tax on self-employment income over the applicable threshold for a total of 3.8 percent Medicare tax.
The tax code bases your self-employment tax on 92.35 percent of your net business income.
Your business deductions are doubly valuable since they reduce income and self-employment taxes. In contrast, personal itemized deductions and “above-the-line” adjustments to income don’t decrease your self-employment tax.
Some types of income are not subject to self-employment tax at all, including:
- most rental income
- most dividend and interest income,
- gain or loss from sales and dispositions of business property, and
- S corporation distributions to shareholders
You calculate your self-employment taxes on IRS Form SE and pay them with your income taxes, including your quarterly estimated taxes.
This is a general explanation of how self-employment taxes work. It’s important to discuss any questions about taxes with your wealth advisor or trusted tax professional.
If you’re looking for information regarding taxes for partners and LLC members, take a look at our article, Self-Employment Taxes for Partners and LLC Members.
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