If you're self-employed as a sole proprietor, partner or LLC member, you may owe the self-employment tax.
The tax is the government's way of collecting Social Security and Medicare taxes from your net self-employment income. Any tax owed is in addition to any income taxes owed to the Feds and your state.
Here's what you need to know about the self-employment tax.
First Stop: Social Security and Medicare Tax
If you're an employee, a portion of your wages is hit with a Social Security tax. The amount is called the wage base and it is linked to the increase in average wages, not the Consumer Price Index. In 2018, the Social Security tax is 12.4% on the first $128,400 in wages (up from $127,200 for 2017).
All of your wages are hit with the Medicare tax of 2.9%. That tax climbs to 3.8% at higher income levels: $200,000 for unmarried folks and $250,000 for married joint-filing couples.
In general, half of these federal employment taxes are withheld from your paychecks while the other half gets paid by your employer. However, you pay the extra 0.9% Medicare tax if you are a high earner. Your employer doesn't owe any part of this.
Second Stop: Self-Employment Tax
Self-employed folks must bear the full brunt of these two taxes combined, either in quarterly estimated tax payments or when they file their federal income tax returns. For 2018, the maximum 15.3% self-employment tax rate is on your first $128,400 of self-employment income (up from $127,200 for 2017). If your income exceeds the $128,400 ceiling, additional net income will be subject to the 2.9% Medicare tax. The additional 0.9% Medicare tax applies once your net self-employment income exceeds the applicable threshold ($200,000 for unmarried individuals or $250,000 for married joint filing couples).
The Future of the Self-Employment Tax
What you pay in self-employment taxes is likely to increase. As the Social Security tax ceiling increases to account for inflation, more and more of your income will be socked with the 12.4% Social Security tax.
According to the Social Security Administration's latest projection, the Social Security tax ceiling is expected to increase to $165,600 for 2022. That would mean a Social Security and Medicare tax bill of $25,337 on self-employment net income of $165,600.
Some observers think there is a good chance the tax ceiling will increase beyond the projected number or even be removed in an attempt to put the Social Security system on a sounder financial footing. Without a ceiling, you would owe the full 12.4% Social Security tax on every dollar you earn.
Now for the Good News
It is not all doom and gloom, however. The good bits of news include:
Your tax advisor also may be able to suggest some ways to lower your self-employment tax bill.
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