This article is for educational purposes and does not constitute legal, employment, or tax advice. For specific advice applicable to your business, please contact a professional. Self-employment comes with a vast list of benefits, from setting your own schedule to keeping all of the profits your business generates. However, self-employed individuals are saddled with at least one drawback: the self-employment tax. If you run a business, it’s crucial to understand how self-employment taxes work and how you may save on these taxes with the right business structure. Here’s a beginner’s guide to self-employment tax and other key information you should know about taxes when self-employed.

What is the federal self-employment tax

Self-employment tax refers to the federal payroll taxes you pay for income derived through self-employment. More specifically, these are taxes for Social Security and Medicare. Here’s how it works.

If you run one of these business types, you probably have to pay self-employment tax:

• Sole proprietorship
• Independent contractor
• Partnership
• Part-time self-employment
• Side hustles

What is the federal self-employment tax

If you work under one of the business structures listed above, you’re required to pay self-employment taxes on your full earnings. You may not know about a method to legally lower self-employment taxes. Business owners that operate as an Corporation or as an LLC taxed as an S Corp may be able to lower their self-employment tax. With this model, self-employment taxes are required on your paychecks. Any additional income is taxed at your regular income tax rate and isn’t subject to self-employment taxes.

Taxes play a big role in your bottom line

When you run a profitable business, paying taxes comes with the territory. But as a business owner, arming yourself with a working knowledge of how self-employment taxes work can help you take steps to minimize what you have to pay legally.

Many people don’t realize that their employer matches this amount. They also pay 6.2% of your income for the Social Security’s Old-Age, Survivors, and Disability Insurance (OASDI) program and 1.45% for Medicare. You have to cover the employee and employer portion when you’re self-employed. That combined tax is the self-employment tax. Certain limits and additional tax rates may apply for six-figure incomes or higher.