This story is part of Taxes 2023, CNET's coverage of the best tax software, tax tips and everything else you need to file your return and track your refund.
If you made money from a side hustle or gig work in 2022, tax time can feel stressful and confusing. We're here to help.
Self-employment taxes are the Social Security and Medicare taxes individuals pay on wages outside of the regular W-2 they receive from their employer. Even if you don't have your own business, the IRS will treat nonemployee compensation as self-employment income and will tax you as a sole proprietor. If you haven't been putting enough money aside for taxes from your contractor earnings, the balance due on your taxes can come as a shock.
However, certain expenses you incurred to make this money can be deducted, as long as you've documented them, according to Logan Allec, certified public accountant and founder of Choice Tax Relief, a tax resolution company. "If you haven't tracked throughout the year, you're going to have to do some digging at this point," Allec said.
Here's what self-employment tax is, how it's calculated, and what to keep in mind if you worked as an independent contractor this year.
Read more: Best Self-Employment Tax Software for 2023
What are self-employment taxes?
Self-employment tax is a federal tax applied to income you generated while self-employed. It consists of two types of taxes: Social Security tax and Medicare tax.
The Federal Insurance Contributions Act of 1935 ensures both employers and employees are regularly paying into Social Security and Medicare funds. The Social Security tax rate is 12.4%, and Medicare tax is 2.9%, leading to a total rate of 15.3% for tax year 2022. Together, these taxes are known as FICA taxes. When you're an employee who receives a W-2, you pay half of the Social Security and Medicare tax burden, or 7.65%, and your employer pays the other 7.65%. Look at a recent pay stub from your employer and you'll see the documentation of this tax withholding.
In contrast, when you're self-employed, you are both the employer and the employee. The pro is that you get to be your own boss, but the con is that you'll be responsible for both halves of the FICA tax. Keep in mind that you'll also owe regular federal and state income taxes on top of the FICA taxes for self-employed income.
How are self-employment taxes calculated?
To calculate your self-employment taxes, take your net self-employment income, which is income minus deductible expenses, and multiply it by 0.9235 (92.35%). Then multiply this number by the FICA tax rate (15.3% for 2022) to arrive at your estimated self-employed tax.
Why 92.35%? Remember that when you're an employee, your employer is covering half your FICA tax burden, or 7.65%. Your employer can write off these payroll tax payments as a deduction on their taxes, and the IRS wants to give self-employed individuals a comparable deduction. Since many taxpayers report self-employment income within their own personal tax return, the IRS applies this 7.65% deduction automatically to net self-employed earnings before determining your tax bill.
As an example, let's say you made $20,000 from a side hustle in 2022, $5,000 of which was used for documented expenses that can be deducted. Your net self-employment income would be $15,000. We'd then multiply this income by 92.35%, then 15.3% ($15,000 x 0.9235 x 0.153) to arrive at $2,119.43 in taxes due.
In comparison, had you not deducted the $5,000 in expenses, your tax burden would have been $2,825.91, a difference of over $700. Taking the time to document and deduct expenses is worth the effort.
Types of expenses you can deduct
The key number in these calculations is net self-employment income. Although the IRS will classify your earnings as business income even if you don't have a registered business, this also means you can deduct certain qualified business expenses, which will help lower the amount of income that gets taxed.
These expenses can include equipment you had to buy, marketing expenses, and mileage or car maintenance costs to drive to and from gigs. Another popular deduction is the home office deduction, which lets you claim part of your rent and utility bills as deductions for the portion of your home used for business. This is usually determined by calculating the square footage of your home that is used for business (in relation to total square footage), then applying that ratio to your home expenses, said Allec. "If you own your home, you can factor in your mortgage interest, property taxes and homeowners' insurance too, then apply the deduction," Allec added.
Self-employment income and expenses are documented on a Schedule C, which then gets attached to Form 1040 to help determine your overall tax liability. One of the best things you can do throughout the year to help lower your self-employed income tax burden is document your expenses, either by saving receipts or using an online bookkeeping service.
Claim expenses within reason
Once you get the hang of deducting expenses, it can be tempting to push the limits and claim as many transactions as expenses as possible to try and lower your tax liability. Most financial experts advise against this.
"On TikTok I see people saying, 'Well, my personal brand is my business, so I can deduct my haircuts,' and all this lifestyle stuff," Allec said. "I think that's where you have to draw the line." A good rule of thumb is that a deduction related to self-employment is reasonable if it's an expense you wouldn't have otherwise incurred in your day-to-day life.
Read more: Maybe Don't Use TikTok for Financial Advice
Frequently asked questions
Is there a cap on how much Social Security tax I owe?
The Medicare tax of 2.9% will apply no matter how much self-employment income you make. In contrast, the Social Security tax only applies to the first $147,000 of your income for tax year 2022. Any W-2 income is included in this calculation.
For example, if you made $150,000 at your day job, and had an additional $10,000 in self-employment income, you'd only owe Social Security taxes on the first $147,000 of your W-2 income.
Is Medicare tax always 2.9%?
No, but you'll be a pretty high earner by the time this number changes. An additional 0.9% in Medicare tax is applied to earnings beyond $200,000 for single filers, $125,000 if married and filing separately and $250,000 if married and filing jointly.
Employers are required to begin automatically withholding the additional 0.9%, but not until the employee has surpassed the threshold in the given tax year. The employer does not have to match the additional 0.9%.
Should I be making quarterly tax payments?
If you expect to owe more than $1,000 in taxes for the year, you'll need to make quarterly payments throughout the year. Failure to do so will result in a penalty. Remember that the $1,000 threshold is after applying any deductions or credits, according to the IRS.
Shore up your self-employment tax game today
Taxes can be intimidating at first, but if you plan to rely on self-employment income for years to come, the best time to learn about them is now. Raise your tax game and you'll keep more of the money you've worked hard to earn throughout the year.