The self-employment tax deduction allows self-employed individuals to deduct a portion of the self-employment taxes they pay. Self-employment tax covers the Social Security and Medicare taxes that self-employed individuals must pay on their earnings. Unlike employees, who split these taxes with their employers, self-employed individuals must pay the full amount themselves.
The self-employment tax rate is:
- 12.4% for Social Security, and
- 2.9% for Medicare.
The IRS allows self-employed taxpayers to deduct the employer-equivalent portion of their self-employment taxes (50%) as an adjustment to income. This deduction is taken on Schedule 1 of Form 1040 and reduces the taxpayer’s adjusted gross income (AGI), lowering their overall tax liability.
For example, if a self-employed individual pays $10,000 in self-employment taxes, they can deduct $5,000 as an above-the-line deduction. This deduction helps offset the additional tax burden self-employed individuals face and ensures they are not taxed twice on the portion of income used to pay their Social Security and Medicare contributions.
Maximizing the self-employment tax deduction is crucial for freelancers, contractors, and small business owners looking to reduce their taxable income and lower their tax burden.