When you own a small business as a sole proprietor, the Internal Revenue Service considers you self-employed. This means you have to calculate self-employment tax, which includes the FICA, or Social Security, tax and the Medicare tax. When it’s time to file your tax return, you use Schedule SE, Form 1040 to report self-employment tax.
When someone works for an employer, he pays only a portion of the FICA and Medicare taxes. The employer is responsible for paying the rest. When you are self-employed as a sole proprietor, you have to pay both the employer and employee portions of these taxes. For most sole proprietors, it’s simpler to calculate FICA and Medicare tax together. The IRS refers to the combined FICA/Medicare tax as self-employment tax.
As of the time of publication, the regular self-employment tax rate is 15.3 percent of your earnings from self-employment. The FICA portion combines the employer and employee portions of the FICA tax, which are 6.2 percent each. The combined rate is 12.4 percent. The Medicare portion is 2.9 percent, which combines the employer and employee contributions of 1.45 percent each. For 2011 and 2012, Congress lowered the employee FICA rate to 4.2 percent and the self-employment FICA rate to 10.4 percent. The Medicare rate remained the same, so the self-employment tax for these years was 13.3 percent.
To calculate FICA self-employment tax as a sole proprietor, first subtract all business expenses and deductions from your revenues to find your net earnings. You get to subtract the employer-equivalent portion of the self-employment tax, which is 7.65 percent, from net earnings. Multiply the remainder by 15.3 percent to figure your FICA tax as a sole proprietor. Suppose you had $100,000 in sales and deductible business expenses of $60,000, leaving you with net earnings of $40,000. Subtract 7.65 percent, or $3,060. Multiply the remaining $36,940 by 15.3 percent to calculate the combined FICA and Medicare self-employment tax of $5,651.82.
The IRS sets an annual cap on the amount of income subject to the FICA tax. For 2012, the cap was $110,100. You do not pay FICA tax on earnings over the cap amount. However, you do pay Medicare tax on all earnings, regardless of the amount. The calculation of Medicare tax for earnings in excess of the income cap is the same as for the combined FICA and Medicare tax, except you use 2.9 percent instead of 15.3 percent, and the employer-equivalent deduction is 1.45 percent instead of 7.65 percent.