What is self-employment tax composed of?

Self-employment tax consists of Social Security and Medicare taxes specifically applicable to individuals who work for themselves. When someone is self-employed, they do not have an employer withholding these taxes on their behalf as a traditional employee would experience. Instead, they must report and pay these taxes directly to the IRS.

Self-employment tax is designed to ensure that self-employed individuals contribute to Social Security and Medicare programs, which provide benefits for retirees, disabled individuals, and healthcare for the elderly. The self-employment tax rate is set at 15.3%, which includes a 12.4% contribution for Social Security and a 2.9% contribution for Medicare.

Understanding self-employment tax is crucial for self-employed individuals as it impacts their net income and financial planning. It helps in ensuring they are contributing to programs from which they may later benefit, similar to employees who have these amounts withheld from their paychecks.