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How the Self-employment Tax Works

        Money | Taxes

Who Pays Self-employment Tax?

There are around 18 million self-employed workers in the United States, but who are they exactly [source: Fox]? The broadest definition of the self-employed is people who are in business for themselves. That's not quite specific enough for the IRS, so it has come up with categories of workers who qualify as self-employed [source: IRS]:

  • A sole proprietor is a person who owns his or her own unincorporated business. A sole proprietor is self-employed, even if the business has other employees.
  • An independent contractor owns and operates his or her own unincorporated business and is paid only for services rendered, not on a salary or wage basis. Independent contractors typically do work for other businesses.
  • Members of an unincorporated partnership each qualify as self-employed, because profits from the shared business are "passed through" to their individual income taxes.
  • Similarly, spouses who run an unincorporated business together can elect to file taxes as a qualified joint venture in which both spouses are considered self-employed.

Unsure whether you're an independent contractor or an employee? Here's a tip: look at the last paycheck you received. Was it written out for the full amount, or did the payer withhold federal and state income tax and FICA contributions? If money is already being withheld from your paycheck, you are an employee and can stop worrying about self-employment tax.

Keep in mind that you don't have to be a full-time self-employed worker to qualify as self-employed. Many self-employed people operate home-based businesses in their spare time, or hire themselves out for part-time work in addition to holding down a "day job." The IRS doesn't care whether you are full-time, part-time or one-time. If you made more than $400 in self-employment income, the IRS wants a piece of it.

One last note, the self-employment tax rules apply to workers of all ages, even folks who are already collecting Social Security and Medicare benefits [source: IRS]. So if you've retired from your office job and start painting houses for some spending money, the IRS still wants its full cut.

OK, next we'll walk you through the process of calculating the self-employment tax itself.