What Is the SECA Tax? A Quick Guide to the Self-Employment Tax
Running a small business means, among other things, paying business taxes. Because small business owners are defined as self-employed taxpayers, the taxes you'll pay differ from those taken out of an employee's paycheck. You'll have to adhere to the Self-Employment Contributions Act (SECA) and pay the SECA tax or self-employment tax.
While navigating SECA tax requirements can feel stressful, it doesn't have to be a difficult process. This guide walks you through what the SECA tax is, who has to pay it, and how to simplify the process using Skynova's business software and templates.
What Is the Self-Employment Contributions Act (SECA) Tax?
The Federal Insurance Contributions Act (FICA) is a federal tax law that requires employers to withhold a set percentage of each employee's paycheck to cover the Social Security tax, Medicare tax, and other insurance costs the government requires all working individuals to pay. It also requires employers to match those withholdings. The total amount paid to the federal government must equal 15.3% of each employees' net earnings, with the employee and employer paying in equal amounts.
Meanwhile, the Self-Employment Contributions Act (SECA) is a tax law that determines how self-employed individuals are to meet those same Social Security and Medicare contributions requirements when reporting self-employment income. The SECA law states that because small business owners are technically both an employer and an employee, they're responsible for the full 15.3% to be paid out of their net business earnings. This is why that tax is called the self-employment tax.
Over 15% of your income can sound like a lot but, luckily, anyone responsible for paying this self-employment tax can deduct half of that 15% when filing their personal federal tax return. There are also other deductions available to small business owners, which we discuss more below.
Who Has to Pay the SECA Tax?
While employers are required to pay FICA taxes, small business owners are required to pay the SECA or self-employment tax regardless of the business entity they run. The Internal Revenue Service (IRS) lists as "self-employed" anyone who:
- Is a sole proprietor or independent contractor
- Is a member of a partnership
- Is otherwise in business for themselves, including in a gig-based or part-time capacity, and doing business as a business entity
This means that a freelance artist selling their work part time falls under the same heading as a sole proprietor with a storefront running their business full time. Anyone who reports business income using a Schedule C form when doing their taxes is considered self-employed and must pay the SECA tax on their business's taxable income.
Understanding the SECA Tax Rates
The 15.3% of your net profit that you pay as your SECA tax is a sum of the percentages that will be paid toward Medicare and Social Security. As of 2020, 2.9% of the SECA tax is the Medicare tax rate and 12.4% is the Social Security tax rate. This rate is higher because Social Security is defined as a program that supports old age, survivors, and disability insurance.
Keep in mind that your SECA tax is based on your net profit, not your gross profit. Your gross profit is what you made before deducting any expenses (such as materials or operating costs), and your net profit is what you're left with after those deductions have been accounted for. This can help ease a bit of the shock many new business owners feel the first time they learn 15% of their income is going toward that tax. It also ensures that your expenses will be paid before any taxes are taken out, so you won't be left scrounging to pay your bills and save up for tax time.
Additionally, if your net profit for the year is less than $400, you don't have to pay the SECA tax. This is beneficial to small businesses just getting off the ground or for anyone whose business is seasonal or only meant to be a partial source of income.
SECA Tax and Deductions
While you must pay the SECA tax to meet your Social Security (which covers retirement and disability insurance) and Medicare contribution requirements, there are deductions a self-employed small business owner can claim on their taxes. Adjusting your income by claiming these allowable deductions means your income will reflect the additional expenses, small and large, that any small business faces throughout the year.
These deductions include:
- Regular business expenses (e.g., inventory and supplies, advertising, and business insurance)
- Travel expenses (e.g., lodging and meal costs)
- Home office expenses, if you run your business from home
- Startup costs for new businesses, which can include registration and licensing fees
- Certifications and other educational costs associated with your business
- Health care costs or additional hospital insurance costs
The biggest deduction associated with your SECA tax is the SECA tax itself. As a self-employed owner, you take on the burden of paying the full 15.3% set by FICA; fortunately, the federal government allows you to claim half of that tax on your personal income tax return. This amount is determined on the worksheets you complete to calculate your overall self-employment tax and is listed on your 1040 tax return form.
How Much Should Small Businesses Set Aside for Self-Employment Tax?
Many business owners choose to hire an accounting professional to help them determine how much money they should set aside throughout the year to pay for taxes. The general recommendation for any business owner required to pay the SECA tax is to set aside about 30% of your income in anticipation of state and federal taxes. There are several methods by which you can get a rough income estimate to calculate that 30%:
- Yearly: For businesses with a fairly steady average income, looking at the previous tax year's numbers can be an easy way to see how much you need to set aside for this year. You can simply go off the average of what you made last year, divide that amount into four, and take 30% from that amount to arrive at your quarterly taxes due. However, if your income seems to be on track to be more than it was last year, setting aside 40% can provide an added assurance that you'll have enough money saved.
- Monthly: If your income isn't quite as steady from year to year or if you're only a few years in, looking at the previous year's average monthly income can give you a better idea of how much to save instead. Find the average monthly income from last year and calculate your 30% from that amount.
- Per payment: This method simply means setting aside about 30% of the money made from each sale or transaction you perform. It's ideal for small businesses just getting started that don't have the previous year's records with which to estimate.
Many owners also have a business checking account from which to pay expenses, but having a business savings account is ideal for taxes. Physically separating the money you need to save will help you avoid the risk of spending too much without realizing it and coming up short at tax time.
Paying the SECA Tax
Your SECA tax payment amount is calculated as part of your personal annual tax return, using additional schedules (and worksheets, as needed). Using the Schedule C form, you'll calculate your net income or the profit left after all allowable deductions have been taken out of your gross income. If you're a partner or member of a limited liability company (LLC), your portion of the business's income is what you'll use to calculate your taxable net income.
Once you've completed the Schedule C form and know your net income, you can complete the Schedule SE form, which will give you your actual SECA tax payment amount. Half of this will then be deducted from your 1040 tax return form (the employer's portion of that 15.3%). The rest will be included in the calculation of your remaining taxes you need to pay as an individual and not just a business owner since you may have other sources of income that will also be taxed at this time.
Manage Your Tax Forms and Accounting With Skynova
Taxes are an inevitable part of running your small business. Stay on top of yours by estimating your SECA tax payment and saving that money throughout the business year. This involves staying on top of invoicing to make sure you get paid and monitoring your inventory and other costs, all of which is made easier by using Skynova's all-in-one invoicing and accounting software. You'll know just how much money you have coming in and how much you'll have going out at tax time.
Maximize your tax deductions by logging your receipts for business-related purchases, travel, and accommodations, and note the use of personal equipment or the cost of maintenance and repair on business equipment right in your Skynova business account. Never miss out on a crucial allowable tax deduction again.
Designed to be easy and intuitive to use, Skynova's software products make running your business, estimating SECA tax payments, and noting deductions throughout the year as simple as possible. Track sales tax and deductible expenses, store receipts, and make notes in your journal or general ledger. Our software and business templates help you keep detailed records, a key to successful business management.