For many of us in the modern US economy, a single job with a single employer is not our gig. We might work full or part-time for an “employer” who pays us an hourly wage or a salary, but we might also have one, two or even 3 “side-hustles,” where we either get paid as a 1099 worker/independent contractor or we sell goods and services through an online distribution channel. Whether you are participating in the gig economy as your sole source of income or to supplement your regular income, you need to know about Self-Employment Tax.
Just by way of background, if you work as an employee in the United States, you must pay your portion of Social Security (old-age, survivors, and disability insurance) and Medicare (hospital insurance) taxes on the wages you earn. Your payments of these taxes contribute to your coverage under the U.S. Social Security system. Your employer deducts these taxes from each wage payment. Your employer must deduct these taxes even if you do not expect to qualify for Social Security or Medicare benefits. For 2018, these tax rates were 12.4% for Social Security and 2.9% for Medicare. If these rates seem high to you, they are. If you are an employee, you only pay half of these “taxes;” your employer pays the other half.
Self-employment Tax is a tax consisting of Social Security and Medicare taxes primarily for individuals who work for themselves. It is the functional equivalent of the Social Security and Medicare taxes withheld from the pay of wage earners who work for an employer.
The self-employment tax rate is 15.3%. The rate consists of two parts: 12.4% for Social Security and 2.9% for Medicare. Unlike a wage earner who is paid by an employer who withholds taxes from wages earned (it’s all in that statement that comes with the pay check), if you owe self-employment tax, you (or your tax preparer – it’s a good idea to use one if you are not a W-2 employee) figure it out yourself using Schedule SE to your Form 1040.
If you think self-employment tax is a scam (and many do since it often sneaks up on them the first time they have to deal with it), there are a few “positives” if you are required to pay it:
- you can deduct the employer-equivalent portion (half) of your self-employment tax when you are determining your adjusted gross income (the amount on which you actually pay income tax). This allows you (as a worker and not a business owner) to be in roughly the same economic position as a wager earner who works for an employer and not for themselves.
- For 2018, only the first $128,400 of your combined wages, tips, and net earnings is subject to the Social Security part of Self-Employment Tax (this same cap applies to wage earners who work for an employer).
- The Medicare part of Self-Employment Tax applies to all of your combined wages, tips, and net earnings in a tax year.
Self-Employment Tax Deduction
As mentioned above, you can deduct the employer-equivalent portion of your self-employment tax in determining your adjusted gross income. This deduction only affects your income tax. It does not affect either your net earnings from self-employment or your self-employment tax.
Who Must Pay Self-Employment Tax?
Here is where this might get a little tricky if you have a side gig to your primary wage earnings from your employer. You must pay self-employment tax in either of the following situations:
- Your net earnings from self-employment (excluding church employee income) were $400 or more; or
- You had church employee income of $108.28 or more.
Gulp . . . Does this mean I owe Self-Employment Tax for my side hustle?
Generally, your net earnings from any self-employment are subject to self-employment tax. The self-employment tax rules apply no matter how old you are and even if you are already receiving or paying Social Security or Medicare taxes through your employer.
Remember, the Social Security part of these taxes max out for both employee and employer at $128,400 for 2018. There is no cap on the Medicare portion of Self-Employment Taxes.
Some Tips to Prepare (or anticipate) Income and Self-Employment Tax for your side hustle
Here are a few tips to keep in mind (even if you don’t like it):
- If you are being paid during the year as an independent contractor or self-employed person, you should stash away a healthy percentage of the money you are paid for both your income and self-employment taxes – the person or company paying your does not withhold for you. The taxes you owe on the money you earn will be due next year on April 15.
- If you truly have a side-hustle and work for someone else who withholds from your wages for state and federal income taxes, make sure you are having your employer withhold enough to also take into account the taxes you will owe on your side hustle income. Its “saving” the money either way.
- If you have not saved any of the money from your side hustle or had your employer withhold extra that takes into account your side hustle income, you will still be required to pay the income and self-employment tax due on your side hustle income and if this money is substantial (or pushes you into another tax bracket) it may be hard for you to come up with the money you owe for taxes.