What is self-employment tax?

In the US, approximately 16 million people enjoy self-employment, while 2.9 million Canadians are following the same route. Even if your entrepreneurial ventures complement income from a wage-earning job, that income is likely going to be subject to some sort of tax.

These entrepreneurs didn’t get into business so they could spend time filing taxes. But it’s a necessary evil that comes with the freedom and flexibility of entrepreneurship.

Below, we’ll go over the self-employment taxes you might have to pay, how to figure out what you owe, and how to pay it to the appropriate government institution.

What is self-employment tax?

If you file your taxes as a self-employed person, and your business is not incorporated, both the US and Canada require these citizens to file an annual individual tax return. This applies if your business is operating as a sole proprietorship, limited liability company (LLC), or partnership, or if you're “otherwise in business for yourself.” The self-employment tax accounts for the taxes your income didn’t pay into when you received it.

US-based self-employed individuals have to pay self-employment tax if they have net earnings of at least $400 in the calendar year. This money goes toward Medicaid and social security. The Internal Revenue Service (IRS) explains that this works similarly to when Medicaid and social security taxes are withheld from an employed wage earner’s paycheck.

Important: Even if you’re currently receiving social security benefits, you can still owe self-employment tax—this income needs to be included.

In Canada, self-employment tax works similarly. You report your income to the Canada Revenue Agency (CRA) as business or professional income and then pay self-employment taxes on that accordingly. This income includes money received from a profession, a trade, manufacturing, or “undertaking of any kind, an adventure or concern in the nature of trade, or any other activity you carry on for profit.” If you don’t include all of your income, you could be subject to a 10% penalty.

Who has to pay self-employment tax?

As mentioned above, people who earn money from their own ventures but outside of an incorporated business entity must pay self-employment tax.

In the US, if you earn a net income of at least $400 in a year, you’ll owe a self-employment tax when you file. This applies to persons of all ages, as well as those receiving social security or Medicare benefits. If you’re a church employee, your net income must exceed $108.28.

The self-employment tax is owed on whatever your net income was—your net income is equal to your total sales minus your cost of goods sold.

Net income = total sales - cost of goods sold

The CRA outlines specifics for who has to pay the self-employment tax as well, including income from:

• Farming
• Fishing
• Rentals
• Partnerships
• A business
• A profession
• Commission
• A calling
• A trade
• Manufacturing
• An undertaking of any kind
• An adventure or concern in the nature of trade

Pretty vague, but it essentially means if you earn money from almost any entrepreneurial endeavor, this income will likely be subject to self-employment tax.

How much is self-employment tax?

How much is self-employment tax in the US?

In the US, self-employment tax is 15.3%. Social security makes up 12.4% while Medicare is the remaining 2.9%.

• Social security tax was mandated by the Self-Employed Contributions Act (SECA) and goes towards retirement, disability, and survivorship benefits. Social security tax is only changed for the first $137,700 of income for 2020, so it’s capped at $17,074.80 (up from $132,900 in 2019).
• Medicare tax is hospital insurance and is applied to all combined wages, tips, and net income—even if your net income surpasses $137,700. There’s an Additional Medicare Tax of 0.9% if your income is over $200,000 (or $125,000 for married couples filing separately or $250,000 for married couples filing together).

If you anticipate owing more than $1,000 in self-employment taxes for the year, the IRS requires quarterly estimated tax payments. Each of these payments should be a quarter of what you expect to owe for the year.

How much is self-employment tax in Canada?

In Canada, self-employment tax in 2020 is 15% on the first $48,535 of taxable income, with increases as follows:

• 20.5% on the next $48,534
• 26% on the next $53,404
• 29% on the next $63,895
• 33% on taxable income over $214,368

For 2019, it was 15% on the first $47,630 of taxable income, plus:

• 20.5% on the next $47,629
• 26% on the next $52,408
• 29% on the next $62,704
• 33% on taxable income over $210,371

When to pay self-employment tax

Self-employment tax is due when you file and pay your taxes. However, there are instances where you’ll need to make payments in multiple installments.

For US-based entrepreneurs, the tax filing deadline is normally April 15, with options to file for an extension. Due to the coronavirus pandemic, the IRS has automatically extended the deadline to July 15, 2020. Estimated quarterly tax payments are typically due April 15, June 15, September 15, and January 15. However, the IRS has also adjusted these for the 2020 tax year, with deadlines for the first two payments extended to July 15.

In Canada, the self-employment tax filing deadline is June 15, with payments due September 1. You may also have to pay in tax installments, though this depends on the province where you’re filing. 2020 payment installments for 2020 are due March 15, September 1 (changed from June 15), September 15, and December 15.

How to calculate your self-employment tax

In the US, you can use the following basic formula:

SE tax = net income * 15.3%

As your income climbs above $137,700 in the US, and above $48,535 in Canada, it gets a bit trickier as you account for different tax rates on different income levels.

So calculating your self-employment tax isn’t as simple as plugging numbers into a formula. It requires sound business accounting practices first—to ensure you’re working with clean, accurate data—and number crunching second.

Once you have numbers to work with, you can use a handy online calculator like these:

• US: Bench.co quarterly tax calculator
• Canada: CRA tax calculator

How to pay self-employment tax

How to pay SE tax in the US

Before you can file or pay any taxes in the US, you’ll need to get a social security number (SSN), employer identification number (EIN), or taxpayer identification number (ITIN). Once you have that and all your necessary financial records ready to go, you can begin the process. You’ll need to following forms:

• Schedule SE (Form 1040 or 1040-SR): The Social Security Administration uses this to determine your benefits under the social security program.
• Schedule C (Form 1040): Report income or loss from your entrepreneurial endeavor.
• Form 8959, Additional Medicare Tax: Determines if and how much Additional Medicare Tax you owe.
• Form 1040-ES: Use this form for estimated quarterly tax payments.

When you’ve filed your return and are ready to make the payments, you can do so in a few ways:

• Online
• IRS2Go mobile app.
• The Electronic Federal Tax Payment System (EFTPS)
• Electronic Funds Withdrawal (this is often the method a professional tax preparer or tax software will use)
• Mail (include a check or money order with your name, address, phone numbers, SSN/EIN/ITIN, and tax year you’re paying)
• At the bank via same-day wire transfer
• With cash, plus a $3.99 fee, at a participating retail location—verify with the IRS first

How to pay SE tax in Canada

In Canada, you’ll need an individual tax number (ITN) before you can prepare and submit Form T2125. This is the Statement of Business of Professional Activities, where you calculate gross income and net income. Use Guide T4002, Self-employed Business, Professional, Commission, Farming, and Fishing Income to help you understand how to fill out Form T2125.

If you have both business and professional income or multiple streams of either, you’ll need to file a Form T2125 for each. See this guide for more information: Interpretation Bulletin IT-206, Separate Businesses.

In Canada, you can also choose how to pay self-employment tax from the following methods:

• My Payment (Visa Debit, Debit Mastercard, and Interac Online)
• Online banking
• Pre-authorized debit
• Credit card, PayPal, or Interac e-Transfer
• Third-party providers (including Wave Payroll)
• At your financial institution
• At a Canada Post location
• Wire transfer (for non-residents)
• Check

How to reduce self-employment tax

If you want to lower how much you owe in self-employment tax, there are a few legal ways to accomplish this:

• Track all business expenses. In the US, business tax deductions for 2015 amounted to more than $1.1 trillion. But the IRS doesn’t track these deductions down for you. Instead, you need to have strong accounting records. If you haven’t already, separate personal and business finances and accounts. This makes it easier to manage your books, but more than a quarter of SMBs don’t—instead, 23% of SMBs find that blending these accounts is their biggest bookkeeping challenge.

• Take an above-the-line deduction. This deduction reduces your adjusted gross income (AGI) by accounting for qualifying expenses. You can include things like rent, utilities, equipment and supplies, insurance, attorney and legal fees, salaries, and contractor fees.

• Make an S-corp election. One of the benefits of an S-corp is that you can save as much as 14.13% in tax savings for every dollar in profit. This is because you pay yourself a salary as an employee, so this can cut into your business’s net income.

• Automate and streamline with the best self-employment accounting software. Did you know you could pay your taxes through a payroll service on a monthly basis? With a tool like Wave, you can automate self-employment tax payments so you keep your business in good standing with the government and avoid any late fees. You can also use tax software like H&R Block to help you prepare your return.

• Hire a pro. A licensed tax professional can help you find ways to reduce your self-employment taxes that you might not have thought of on your own. Wave Advisors, for example, is a year-round professional tax service with specific experience working with busy entrepreneurs like you.