Articles · Basics · Individual Income Tax and Form 1040
Self-Employment Tax Explained
Self-employment tax is how sole proprietors and many partners pay into Social Security and Medicare. It applies in addition to regular income tax.
The rate
The combined rate is 15.3%. That is 12.4% for Social Security, up to an annual wage base, plus 2.9% for Medicare with no limit. An Additional Medicare Tax of 0.9% can also apply above certain income levels.
Employees pay half of these taxes and employers pay the other half. Self-employed people pay both shares.
The calculation
Start with net earnings from self-employment, usually Schedule C profit. Multiply by 92.35%, then apply the 15.3% rate. The result is reported on Schedule SE if net earnings are $400 or more.
For example, $50,000 of profit gives $46,175 of net earnings, and about $7,065 of self-employment tax.
The offsetting deduction
Half of the self-employment tax is deducted as an adjustment to income. This lowers income tax, but it does not lower self-employment tax itself. Using the example above, about $3,532 would be deducted in reaching AGI.
Who pays self-employment tax
Sole proprietors pay it on Schedule C profit. General partners generally pay it on their share of partnership trade or business income and on guaranteed payments for services. Limited partners generally pay it only on guaranteed payments for services, although the treatment of LLC members and active limited partners is an area of dispute.
S corporation shareholders do not pay self-employment tax on their share of profit. They pay payroll tax on wages instead, which is why reasonable compensation matters. Investment income, such as dividends and capital gains, is generally outside self-employment tax. Rental real estate income is usually excluded too, unless the owner is a real estate dealer or provides substantial services to occupants.
How wages and self-employment income interact
The Social Security portion stops once combined wages and self-employment earnings reach the annual wage base. Someone with a full-time job and a side business therefore applies wages to the wage base first. If wages alone reach the limit, the side business pays only the 2.9% Medicare portion.
The Additional Medicare Tax of 0.9% applies when combined earnings exceed $200,000 for single filers, $250,000 for joint filers, or $125,000 for married individuals filing separately. It is calculated on Form 8959, and no employer share exists.
A fuller worked example
A consultant has $120,000 of Schedule C profit and no wages. Net earnings are $120,000 × 92.35% = $110,820. Assuming this is below the wage base, self-employment tax is $110,820 × 15.3% = about $16,955. The consultant deducts half, about $8,478, on Schedule 1.
Income tax is then calculated on what remains after this adjustment and any other deductions. Because the two taxes stack, it is common for a new consultant to underestimate the total. A simple rule of thumb is to set aside a percentage of every payment, then refine it with the first estimated payment.
Common planning points
Legitimate business deductions reduce self-employment tax as well as income tax, because they lower net earnings. Deductions taken below the line, such as itemized deductions, do not. Multiple businesses are combined on Schedule SE, so a loss in one can offset a profit in another.
Paying self-employment tax also builds Social Security earnings credits. Moving income to an S corporation can reduce payroll tax, but it adds payroll, return preparation, and compliance costs, so the saving should be modeled before making an election.
A preparer's checklist
Confirm that the income is from a trade or business carried on by the taxpayer, then combine the results of all such businesses. Include partnership earnings from Schedule K-1 and any Form 1099 amounts, and remove items that are not self-employment income.
Check whether Form W-2 wages already use part of the Social Security wage base for the year, and test the Additional Medicare Tax thresholds on Form 8959. Claim half of the tax on Schedule 1, and confirm that estimated payments were made for the year.
Then use the results to set next year's estimates. Keep records of expenses and mileage, because any deduction disallowed on exam will increase both income tax and self-employment tax.
Key takeaways
- The rate is 15.3% on 92.35% of net earnings, subject to the wage base.
- Schedule SE applies from $400 of net earnings.
- Half of the tax is deductible for income tax.
Frequently asked questions
Do I pay self-employment tax if my business has a loss?
No self-employment tax is due on a net loss. If you have more than one business, their results are combined first.
Does the qualified business income deduction reduce self-employment tax?
No. The QBI deduction reduces taxable income for income tax purposes, but it does not reduce net earnings from self-employment.
When is self-employment tax paid?
It is reported on Schedule SE with Form 1040 and is usually paid during the year through quarterly estimated payments.
For general education only, not tax advice. Tax law changes often, so confirm current rules and amounts with primary sources.