Self-Employment Tax vs. Income Tax - What's the Difference?
When you’re self-employed, you’re responsible for paying both the employer and employee portions of the Social Security and Medicare taxes. This is known as the self-employment tax. In addition, you’ll likely have to pay income tax based on your total taxable income, including your self-employment income. Here’s how to calculate both taxes.
Key Takeaways
- FICA tax is an employment tax that is taken out of employees' paychecks to fund Social Security and Medicare. Half is paid by the employee and half is paid by the employer.
- SECA tax is the self-employment version of FICA to fund Social Security and Medicare. Self-employed people pay the entire tax themselves since they are both the employee and employer.
- Income tax is paid on a person’s taxable income, including income from wages, self-employment, pensions, investments, and other sources. Employees typically make income tax payments through withholding from their paychecks.
- Self-employed individuals often make estimated tax payments during the year to pay both their self-employment and income taxes. This is similar to the withholding from an employee's paycheck withholding.
Self-employment tax vs. income tax
Self-employment (SE) tax is paid by individuals that work for themselves to fund Social Security and Medicare and is based on their earnings. It was authorized by the Self-employed Contributions Act and is often referred to as SECA taxes.
SE taxes take the place of what typically gets paid by people that work for an employer through withholding from their paychecks. This withholding from paychecks is known as FICA taxes.
FICA taxes were authorized by the Federal Insurance Contributions Act. Both the SECA and FICA taxes are calculated as a percentage of the individual's net earnings either from their employer or from self-employment.
Income tax, on the other hand, is a tax on a person’s taxable income. This includes income from wages, self-employment, retirement income, Social Security benefits, investments, and other sources. The amount of income tax that has to be paid varies depending on many factors including an individual's filing status and income level. Generally, the higher the income, the higher the rate of income tax.
What is self-employment (SE) tax?
SE tax is similar to the federal payroll (FICA) taxes that get paid by employers and their employees when working at a job other than for yourself. It is paid based on the amount of self-employment income and is used to fund Social Security and Medicare. The purpose of SE tax is to ensure that self-employed individuals contribute to Social Security and Medicare, just like employees and their employers.
SE tax is calculated based on a person's net self-employment income. The current rate for SE tax is 15.3%, which is split 12.4% for Social Security and 2.9% for Medicare. This rate is the same for employees and their employers, but instead of being split between the two, a self-employed person pays the entire tax themselves.
Once the combined total of your wages, tips, and self-employment income goes past the year's Social Security wage base, the rest of your income is no longer subject to the Social Security portion of SECA or FICA tax. For 2024, this wage level is $168,600, but it's adjusted each year for inflation.
Also, if your income goes past certain levels, you can be subject to an additional Medicare tax of 0.9%.
All self-employed individuals are required to pay self-employment tax, unless their net income is below a certain threshold. For most self-employed individuals, the 2024 tax year threshold is $400.
Who does the IRS consider self-employed?
The IRS considers self-employed individuals to be those who are in business for themselves, such as independent contractors, freelancers, sole proprietors, and certain partners in partnerships. These self-employed individuals are responsible for reporting their own income and SE taxes rather than receiving a W-2 from an employer that reports similar information for employees.
What is income tax?
Income tax is a tax that is paid to the government based on your taxable income. This tax is usually withheld from your paycheck by your employer as an estimate of the amount that you calculate on your tax return each year. It usually shows up on your paystub as "federal withholding."
For employees, the amount of income tax that is withheld from your paycheck is determined by the information you provide on your Form W-4. This form includes information such as your filing status, number of dependents, and other deductions you may be eligible for.
The amount withheld from your paycheck for federal withholding is then sent to the government to pre-pay your income taxes. When you prepare your tax return for the year you will determine if you overpaid and have a refund or underpaid and owe more tax.
Quarterly payments
The IRS considers your income taxes to be pay-as-you-go rather than due at the end of the year. This means that if you owe above a certain amount of tax for the year then you need to make estimated tax payments throughout the year rather than paying everything when you file your tax return.
Taxpayers make estimated tax payments when they do not have enough money sent to the IRS by other means, such as through withholding from their paycheck, to cover what they will owe in taxes for the year. These payments are often referred to as quarterly payments because the year is divided into four payment periods, or quarters, when calculating the amount to be paid.
Failing to make sufficient quarterly payments throughout the year can lead to interest and penalties on an underpayment when you prepare and file your tax return.
TurboTax Tip:
Quarterly payments are payments made to the IRS to cover taxes owed that are not paid by another source such as withholding from your paycheck.
Who pays income taxes?
As a taxpayer, you are required to pay income taxes on the taxable income that you receive, including wages, pensions, Social Security benefits, tips, bonuses, investments, and other sources of income. The amount of taxes you owe depends on many factors including the type of income, your income level, filing status, and available deductions and credits.
How to calculate income tax
Income tax is calculated by taking your total taxable income for the year and subtracting any adjustments and deductions you may be eligible for. Then, you will use the tax rates for your filing status to determine your tax. If you are eligible for tax credits, these can reduce the amount of tax you owe.
For example, if your taxable income after adjustments and deductions is $50,000 and you are filing as Single, you would look up the amount of your taxable income that falls into each tax bracket and add them up. For 2024, this would include 10% of the first $11,600, 12% of the amount from $11,601 to $47,150, and 22% of the amount from $47,151 to $50,000. This is $1,160 + $4,266 + $627 = $6,053. You would then subtract tax credits you are eligible for to get your final tax liability. The TurboTax TaxCaster can help you estimate your income tax.
Federal tax brackets refer to the income levels at which different tax rates apply. The tax rate increases as income increases, so taxpayers in higher brackets pay a higher percentage of their income in taxes. This is known as a progressive tax system.
Additionally, there are different sets of tax brackets based on your filing status including Single, Married Filing Jointly, Married Filing Separately, Head of Household, and Qualifying Surviving Spouse. While each filing status has the same tax percentages in the tax brackets, the percentages are applied to different amounts of taxable income.
What if I have both self-employment income and income from an employer?
When an individual has both self-employment income and income from an employer, they’ll need to use both incomes to determine their tax. This includes SE tax and income tax.
- For self-employment income, you will need to file a Schedule C form with your Form 1040 tax return as well as Schedule SE. Schedule C reports the income and expenses related to the self-employment activity. Schedule SE calculates the amount of SE tax due on the self-employment income from Schedule C.
- For the income from working for an employer, the information is typically provided on a Form W-2 from the employer. The income from your employer is added to your self-employment and other taxable income to come up with your total taxable income (after available adjustments and deductions).
The payroll taxes from your W-2 job can help lower what you owe for your SE tax. As noted earlier, the maximum amount of wages, tips, and self-employment income subject to the Social Security tax for 2024 is $168,600.
So, if you had a W-2 job where you made $160,000 and made another $20,000 from self-employment, then only $8,600 ($168,000 - $160,000 = $8,600) of your self-employment income would be subject to the Social Security portion of the SE tax (12.4%). But typically, all of your earned income from working is subject to the Medicare portion of the SE tax (2.9%).
This is helpful because your employer pays half of the Social Security portion on the $160,000 of wages and you only pay this on the rest up to the maximum for the year.
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