Self-Employment Tax
BusinessGlossary term
Definition
A tax that self-employed individuals pay to cover Social Security and Medicare contributions, equivalent to both the employer and employee portions of these payroll taxes. As of recent years, the self-employment tax rate is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare, applied to net self-employment income. Self-employed individuals can deduct half of this tax on their personal income tax return, and choosing to be taxed as an S-corporation can help reduce this obligation.
Related terms
- Quarterly Estimated TaxTax payments that self-employed individuals, freelancers, and business owners must make four times per year to cover their expected income tax, self-employment tax, and other applicable taxes. Since these earners do not have taxes withheld from a paycheck like traditional employees, they are required to estimate and pay their tax obligations on a quarterly schedule. Failing to make estimated tax payments or underpaying can result in penalties and interest charges from the IRS.
- Sole ProprietorshipThe simplest business structure in which a single individual owns and operates the business with no legal distinction between the owner and the business entity. While easy and inexpensive to set up, a sole proprietorship offers no personal liability protection, meaning the owner's personal assets are at risk for business debts and lawsuits. All business income is reported on the owner's personal tax return and is subject to self-employment tax.
- S-CorporationA special tax designation available to eligible corporations and LLCs that allows business income to pass through to shareholders' personal tax returns, avoiding the double taxation that C-corporations face. To qualify, the business must have no more than 100 shareholders, all of whom must be US citizens or residents, and the company can only issue one class of stock. S-corps also allow owner-employees to potentially reduce self-employment taxes by splitting income between salary and distributions.
- Income StatementA financial statement that summarizes a company's revenues, costs, and expenses over a specific period, ultimately showing whether the business made a profit or loss. Also known as a profit and loss (P&L) statement, it is one of the three core financial statements used to evaluate a company's performance. The income statement helps business owners and investors understand where money is coming from and where it is being spent.
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