If you've been looking into information about taxes for gig workers (Doordash, Instacart, Uber, Lyft, Grubhub, etc.), you may have noticed this ugly phrase pop up:
The first time you see that phrase can throw you for a loop. Why am I being taxed for being self-employed? How does that seem fair?
It can be a confusing topic. We'll tackle that subject in this article, looking at the following:
- What are self-employment taxes?
- Comparing self-employment taxes to employment taxes
- How self-employment taxes are figured out
About This Article
The purpose of this article is to explain self-employment taxes for gig economy delivery drivers in the United States. We do not get into taxes for other countries. This is part of a series of articles on taxes for independent delivery professionals. We'll link to other articles in the series where appropriate. You can also see a complete list at the end of this article.
We focus on how these taxes impact independent contractors in the gig economy. However, these deductions are available for most self-employed individuals who operate sole proprietorships, partnerships, and certain other business structures.
This is not tax advice and should not be taken as such. The purpose is to educate and inform about these deductions. You should seek guidance from a tax professional to determine how these deductions would work in your tax situation.
What is Self-Employment Tax?
Let's start with this question: Why are we even discussing self-employment tax? It's because when you sign up as an independent contractor, you agree to provide services as a business rather than as an employee. You are now a business owner, meaning you are self-employed.
Self-Employment taxes are not a tax for being self-employed. They are not an additional tax but the self-employed person's version of employment taxes.
I know that doesn't completely clear things up, does it? Let's put it another way: It's how the self-employed handle their Social Security and Medicare tax obligations.
When the government passed the Federal Insurance Contributions Act (FICA) in 1935, it set things up so that Social Security was taken out of a person's paycheck. Medicare was added in 1965.
This created inequity in that self-employed individuals did not have to pay Social Security, nor were they covered by it. In 1954, the Self-Employed Contributions Act created the Self-Employment tax (sometimes known as SECA tax).
Self-Employment tax consists of 12.4% of one's earnings for Social Security and 2.9% for Medicare.
Comparing employment tax and self-employment taxes
One of the best ways to understand self-employment tax is to compare it to how employment tax works with a paycheck. Four things stand out when you do this.
- Social Security and Medicare are charged on every dollar of income.
- We pay twice as much self-employment tax as is taken out of paychecks
- Uncle Sam still gets the same amount of money
- We file our Social Security and Medicare taxes while employees don't
Social Security and Medicare are charged on every dollar.
One of our programs at a non-profit I worked at was a youth employment training program. That first paycheck was an eye-opener for kids, finding out that money was taken from their checks. FICA taxes were deducted from the smallest of paychecks.
This is a significant difference from income tax. Adjustments, deductions, and things lower your taxable income for income tax. None of that applies to FICA taxes. The tax liability is there from the first dollar earned.
We pay twice as much percentage as is deducted from an employee check.
An employee has 6.2% taken out for Social Security, with an additional 1.45% removed for Medicare. That total of 7.65% is half of the 15.3% that makes up self-employment tax.
However, Uncle Sam gets the same percentage from both.
In the end, the U.S. Government still gets the complete 15.3% of an employee's pay. That's because an employer has to pay half of the total amount. Thus the employee pays 7.65%, and so does the employer. When you are self-employed, you have to pay both halves.
We have to file the taxes when an employee doesn't.
As employees, we don't often think about these taxes other than noticing them on our pay stubs. We don't have to file any forms or do anything. The boss just takes it out of your check and sends it in.
However, when we're not employees, we're on our own to ensure the money is sent in and the paperwork is filed. To simplify things, filing self-employment taxes is part of the income tax process.
How Self-Employment Tax is calculated
One thing about self-employment tax is that it's pretty straightforward. You don't have to go through all the hoops you do with income tax: deductions, itemizing, dependants, adjustments, etc. It pretty much boils down to determining your income and calculating it by 15.3%.
The determining income part of it all comes with IRS form Schedule C. You list your business earnings and expenses. Then, you deduct costs from your income to determine your profit.
The next step is to fill out IRS form Schedule SE. This is the form that determines your Self-Employment Tax. For gig workers, the process is pretty simple. It consists of two steps.
Step 1: Multiply income by .9235. This is very much like writing off half of your self-employment tax. Remember our comparison of employee versus self-employed and how an employer pays half of the FICA taxes? The employer gets to claim that 7.65% of wages as a business expense. This step levels the playing field, allowing you to deduct the “employer's half.”
Step 2: Multiply the adjusted amount by 15.3%. This determines your Self-Employment tax for the previous year.
If you have less than $400 in total self-employment income (profit after expenses), you will not need to file form Schedule SE or pay self-employment tax.
If less than $400, you don't owe self-employment tax; don't file this schedule unless you have an amount on line 1b.2019 IRS Schedule SE line 4
When you've completed these two steps, you include Schedule SE with your income tax return. During the income tax process, after figuring out your income tax bill, your Self-Employment tax is added to your income tax (Line 23 of the 2021 1040 form). This determines the total taxes that must be paid.
While the IRS makes it look pretty complicated, the overall process is pretty straightforward.
However, Self-Employment tax is the one thing that gets more gig workers in tax trouble than any other part of the process. That's because many are not expecting it.
As employees, we only really deal with income tax. The FICA taxes are taken care of for us. The money is taken out of our paycheck as we go along. However, when we're self-employed, we're on our own.
The part that catches so many off guard is that it's charged against every dollar of profit. We're used to not paying income tax until our income reaches a certain level. In this way, self-employment tax is a different game altogether.
With these things in mind, there are two things you can do to avoid a financial nightmare during tax season.
Track your miles and expenses. Remember that while tax deductions don't reduce your self-employment tax, business expenses do. Your tax is based on profit. Recording your mileage (62.5 cents per mile for the second half of 2021) and other business expenses can keep self-employment taxes better under control.
Set aside money for taxes regularly. There's a reason that Uncle Sam takes money out of employee paychecks throughout the year. If they didn't withhold anything, a significant number of people would be unable to pay their tax bills at year's end. You can read more here about how your best practice is to set aside money weekly for taxes.
The Delivery Driver's Tax Information Series
Tax Guide: Understanding Your Income
The following three articles help you understand what your real income is as an independent contractor.
Tax Guide: Understanding Your Expenses
The following eight articles help you understand the expenses you can claim on your Schedule C. Most of these are about your car, your biggest expense.
Filling Out Your Tax Forms
Once you understand your income and expenses, what do you do with them? Where does all this information go when you start filling out your taxes?