Self-Employment Tax Explained: Rates, Calculation, and Ways It Differs by Entity

Self-employed owners often notice on their first return that the tax bill is larger than income tax alone would explain. The difference is self-employment (SE) tax: the Social Security and Medicare taxes that an employer and employee would otherwise split. Understanding it clarifies why entity choice and salary decisions matter.

What it is

Employees pay 6.2 percent for Social Security and 1.45 percent for Medicare through payroll withholding, and the employer pays the same amounts. When you are self-employed, you are both employer and employee, so you pay both halves through the SE tax. The combined rate is 15.3 percent: 12.4 percent for Social Security and 2.9 percent for Medicare.

How it is calculated

Net earnings from self-employment: generally net profit from Schedule C (or your share of partnership income and guaranteed payments), reduced by certain items.
Multiply by 92.35 percent. This adjustment approximates the deduction an employer would get for its half of the tax.
Apply the rates: 12.4 percent Social Security tax on earnings up to the annual Social Security wage base (which adjusts each year), and 2.9 percent Medicare tax on all earnings.
Additional Medicare tax: an extra 0.9 percent on earnings above thresholds (which are not indexed), based on filing status, applies to combined wages and SE income. It is reported separately.

You compute SE tax on Schedule SE and report it on your personal return. It is in addition to income tax.

The deduction for half

You may deduct half of the SE tax in computing adjusted gross income. This reduces income tax but does not reduce SE tax itself. It also reduces net earnings used in retirement contribution formulas for self-employed owners. Note that the deduction does not reduce the SE tax base.

Minimum threshold

If net earnings from self-employment are less than $400, SE tax generally does not apply. Above that, it applies from the first dollar.

Who pays it, by entity

Sole proprietors and single-member LLCs (disregarded): SE tax on net business profit. See single-member LLC taxes.
Partners and LLC members (taxed as partnerships): SE tax generally applies to the distributive share and guaranteed payments of active partners and members. The treatment of limited partners and passive members has particular rules and open questions. See multi-member LLC taxes.
S-corp shareholders: wages are subject to payroll tax (the corporation withholds the employee half and pays the employer half), and the pass-through income on the K-1 is not subject to SE tax. This is the reason for the S-corp planning around reasonable salary. See when to elect S-corp status and S-corp reasonable compensation.
C-corp owner-employees: wages are subject to payroll tax, and dividends are not.
Rental income: generally not subject to SE tax unless you provide substantial services (like a hotel), or you are a real estate dealer.
Investment income: interest, dividends, and capital gains are generally not subject to SE tax (though the net investment income tax may apply to some).

Once earnings exceed the Social Security wage base, the 12.4 percent portion stops for the year, but Medicare continues, including the additional Medicare tax. This makes marginal SE tax lower for very high earners. A person with wages from an employer and SE income has the wage base applied against combined earnings, so W-2 wages reduce the room for Social Security tax on SE income.

Planning ideas

Common ways owners manage SE tax, all subject to legal requirements:

S-corp election: reduces SE tax exposure on profit beyond a reasonable salary, at the cost of payroll and compliance. Not a fit for everyone.
Legitimate deductions: every deductible business expense reduces net earnings and therefore SE tax. Keep records. See bookkeeping systems for small business.
Retirement contributions: contributions for a self-employed owner reduce income tax, and the computation of the contribution takes SE tax into account, but they do not reduce SE tax for sole proprietors because they are taken below the line. For S-corp owners, deferrals reduce Box 1 wages but not Social Security and Medicare wages.
Hiring family members in appropriate structures (see hiring your children).
Timing income and expenses under the cash method within the rules. See cash vs accrual accounting.
Ensuring correct entity classification for the business.

Avoid arrangements that are marketed as ways to eliminate SE tax without changes in the business reality, such as paying yourself entirely through distributions while performing full-time work.

SE tax builds your Social Security earnings record, which determines future benefits. Lower reported SE earnings (through aggressive strategies) can reduce future benefits. It is a tradeoff to consider, in addition to the current tax savings.

Payment

SE tax is paid with your estimated taxes during the year and reconciled on your return. See estimated taxes guide. You should include it in your quarterly calculations. Sole proprietors do not have SE tax withheld unless they have other wage income and increase withholding.

Common mistakes

Forgetting SE tax when setting aside money for taxes.
Assuming S-corp distributions avoid all tax.
Assuming an LLC avoids SE tax. A default LLC does not.
Ignoring the additional Medicare tax at higher incomes.
Deducting half of SE tax incorrectly, or believing it reduces SE tax.
Treating rental income as subject to SE tax when it is not, or the reverse.
Using distributions to avoid payroll tax while working full time.
Missing deductions that reduce net earnings.

Special situations

Clergy, farmers, fishing crews, and certain other workers have specific rules.
Foreign-related rules: totalization agreements can affect who pays.
Nonresident aliens often have different treatment.
Church employees, statutory employees, and others have special SE rules.
Community property spouses: partnerships between spouses might use qualified joint venture rules, which affects how SE tax is split. See hiring family members.

For help evaluating SE tax and whether structure changes make sense for your business, AE Tax Advisors can assist, and a discovery call is a good first step.