When you work for yourself instead of an employer, you are responsible for paying the full amount of Social Security and Medicare taxes on your net earnings, not the gross amount of your revenue. The Internal Revenue Service calls this tax the self-employment tax. Neither "gross profit" nor "net profit" apply to the self-employed -- these are terms used in other forms of business organization.
Employers pay a share of your Social Security and Medicare taxes in addition to what they take out of your paycheck. If you are in business for yourself, however, you are responsible for the entire amount. Combined Social Security and Medicare taxes are referred to as self-employment tax. You are considered self-employed when you are a sole proprietor, independent contractor, member of a partnership or LLC, or otherwise in business for yourself.
Net earnings are the amount left over after you subtract all deductible business expenses from your self-employment revenues. This is different from gross profit, which is equal to net sales minus cost of goods sold. Net earnings are also different from net profit, which is equal to gross profit minus operating expenses, including taxes. Net earnings represent your pretax income from self-employment and are treated as personal income -- not as business income -- by the IRS.
The Social Security portion of self-employment tax is normally equal to the 6.2 percent an employee contributes plus the employer's share of 6.2 percent, for a total of 12.4 percent. The employee share was temporarily reduced to 4.2 percent in 2011 and 2012, making the self-employment rate for those tax years 10.4 percent. The Medicare portion of self-employment tax equals 2.9 percent, which is the sum of the employee and employer rates of 1.45 percent each. This brings the normal self-employment tax rate to 15.3 percent. There is an income cap on the Social Security portion. For example, the cap as of 2012 was $110,100, an increase from the previous level of $106,800. There is no income cap on the Medicare portion.
Figuring the Tax
You are allowed to deduct the employer-equivalent portion from your net earnings before calculating self-employment tax. This means you multiply 92.35 percent of your net earnings from self-employment by 15.3 percent to figure your self-employment tax. Suppose your net earnings equal $50,000. Multiply $50,000 by 92.35 percent, leaving $46,175. Multiply $46,175 by 15.3 percent. Your self-employment tax equals $7064.78.
Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.