The self-employment (SE) tax is, as the name suggests, a tax on self-employment income, and consists of Social Security and Medicare taxes, otherwise known as FICA (Federal Insurance Contributions Act) taxes. The employment tax, often referred to as the payroll tax, is also assessed on employees. For 2013 and afterwards, the employer pays 7.65% of the Social Security (SS) tax and 1.45% of the Medicare tax on behalf of the employee; the employee pays the remaining part. Since, by definition, self-employed people do not have employers, they must pay the full amount of the tax. However, just as employers can deduct their share of the employment tax paid to their employees, the self-employed are permitted to deduct that portion as well. Additionally, they are permitted to deduct 50% of the SE tax paid as an adjustment for gross income on Form 1040.
The self-employment tax is calculated on Schedule SE, Self-Employment Tax, which must be filed by every taxpayer if self-employment income is greater than $433.13 (92.35% × income ≥ $400), even if they are already retired and collecting Social Security and are enrolled in Medicare. If the taxpayer has more than 1 business, then the income is netted among all businesses and listed on Schedule SE.
Schedule SE consists of 2 major parts: Short Schedule SE and Long Schedule SE. The Short Schedule can be used by taxpayers whose total earnings are within than the Social Security contribution and benefit base (hereafter: SS wage base) and who only earned wages from employers who withheld the SE tax. Most other taxpayers must use the Long Schedule SE.
Self-employment tax must be paid on net business income or income from a partnership, limited liability company, or S corporation. If the taxpayer has more than 1 business, then self-employment income is paid on the net earnings from all businesses. So losses in 1 business can be offset by the income of another. Although business expenses reduce the amount of net earnings, and, therefore, self-employment tax, many of the other deductions on Form 1040, such as contributions to retirement plans, and most tax credits do not reduce self-employment tax.
The self-employment tax rate is 15.3%: 12.4% of that part goes to Social Security and 2.9% for Medicare. This rate applies to 92.35% of self-employment income within the SS wage base:
|SE Income||SE Taxable|
|SE Taxable Income = SE Income × 92.35%|
The 92.35% rate is derived from the fact that self-employed taxpayers can deduct the employer's portion of the tax, which is 7.65% (100% – 7.65% = 92.35%). The Medicare tax applies to 92.35% of all earned income. So for the self-employed, for 2016, the maximum Social Security tax will be paid by those who earned at least $137,737. Note, however, that since employees cannot deduct the employer portion of the employment taxes, the maximum Social Security tax paid by employees will be those who earn at least the SS wage base, which is $127,200 for 2015.
Self-Employment Taxable Income = Net Business Income × .9235
Self-Employment Tax = Self-Employment Income × .153
Since multiplication is associative — meaning that the order of multiplication does not matter, e.g. (a × b) × c = a × (b × c) — the actual self-employment tax rate can be found by the following equation:
Actual Self-Employment Tax Rate = .9235 × .153 = 0.1412955 = 14.12955% ≈ 14.13%
Example 1: 14.13% is a good estimate of the total SE tax. Out of self-employment earnings of $100,000, $92,350 is subject to self-employment tax, = $92,350 × .153 = $14,129.55, which is 45Â¢ short of $100,000 × .1413.
People who earn more than the SS wage base only have to pay the Medicare tax on the additional income. Although the Medicare tax rate for the self-employed is nominally 2.9%, the actual rate is lower because, like the SS tax, it only applies to 92.35% of self-employment income:
Actual Self-Employment Medicare Tax Rate = .9235 × .029 = .0267815 ≈ 2.68%
The self-employed taxpayer can deduct ½ of the tax paid, which is equivalent to the employer's portion.
Example 2: The taxpayer in Example 1 can deduct $14,129.55 × .5 = $7,064.78
Self-employment tax is additional to the ordinary income tax on earned income. It is also a regressive tax because it places a greater tax burden on lower-income taxpayers. Only refundable tax credits — earned income credit, additional child tax credit, the adoption credit, the health insurance premium tax credit, and 40% of the American Opportunity credit — can lower the self-employment tax liability. Since most tax credits are nonrefundable, they cannot be applied to the self-employment tax.
Even the effective SE tax rate (= SE Tax Paid / Income) is higher on lower income people than it is for higher income taxpayers, because of the SE tax deduction, as can be seen in the table below.
|Income of 2 Taxpayers||$14,880||$118,500|
|Lowest Income for which Single Taxpayer Becomes Ineligible for EIC||$14,880|
|Social Security Wage Base||$118,500|
|Employment Tax Rate||15.30%|
|Deductible SE Tax Rate||50.00%|
|Self-Employment Tax = Wages × .9235 × .153 =||$2,102.48||$16,743.52|
|SE Deduction = SE Tax × Deductible SE Tax Rate||$1,051.24||$8,371.76|
|Tax Savings from SE Deduction = SE Deduction × Marginal Rate =||$105.12||$2,344.09|
|Effective SE Tax = SE Tax – SE Deduction =||$1,997.35||$14,399.42|
|Effective SE Tax Rate = Effective SE Tax / Income =||13.42%||12.15%|
The effective SE tax rate ranges from 13.42% for a single taxpayer with an income equal to the phaseout amount for the earned income credit to 12.15% for a taxpayer who earns the SS wage base. So the effective SE tax rate for the poor taxpayer is 1.27% higher than for the much wealthier taxpayer.
Note that taxpayers with even higher income than the SS wage base pay even lower effective SE tax rates, because no additional SS taxes are assessed on the higher income plus ½ of the Medicare tax, even that portion above the SS wage base, is deductible.
A new additional Medicare tax of 0.9% also applies to taxpayers with incomes greater than $200,000, or $250,000 for a joint return ($125,000 for taxpayers filing separately). The 2.9% rate applies to all earned income; the 0.9% applies to income above the threshold amount. Only the employee pays the 0.9% tax — there is no employer contribution — so the self-employed also only pay the 0.9%. For these taxpayers, investment income is also subject to an additional Medicare surtax of 3.8%. Take note, however, that no portion of either the additional Medicare tax or the 3.8% Medicare surcharge can be deducted against gross income. The ½ SE tax deduction only applies to the 12.4% Social Security tax and the 2.9% Medicare tax.
Married couples filing jointly must each file Schedule SE for income that they earn from their business or respective shares of the business. Also, business income is not treated as community property, so the spouse who earns the money must pay the tax.
Generally, investment income is not subject to the self-employment tax. Limited partners do not have to pay self-employment tax, but general partners do, since they are active in the business. Generally, partners and limited liability company members owe self-employment tax for compensation received for services rendered. If they are not active in the business, then it is considered investment income not subject to the self-employment tax.
The self-employment tax also applies to foreign earned income. Although tax law allows the deduction or exclusion of foreign income that is taxed in the foreign country from ordinary income taxes, it does not apply to the self-employment tax. Since the maximum foreign earned income that can be excluded is less than the SS wage base, the entire amount is subject to self-employment tax.
How Self-Employment Tax Is Calculated on Schedule SE
|SE Taxable Income = SE Income × 92.35%|
|If SE Taxable Income||≤ SS Wage Base||then SE Tax||=||SE Taxable Income × 92.35% × 15.3%|
|If SE Taxable Income||> SS Wage Base||then SE Tax||=||SS Tax + Medicare Tax|
|=||SS Wage Base × 12.4% + SE Taxable Income × 2.9%|
- Example 3:
- SE Earnings = $100,000
- SE Tax = $100,000 × 92.35% × 15.3% = $14,129.55
- Example 4:
- 2015 SS Wage Base = $118,500
- SE Earnings = $200,000
- SE Taxable Income = $200,000 × 92.35% = $184,700
- SE Taxable Income
- = $118,500× 12.4% + SE Taxable Income × 2.9%
- = $14,694 + $184,700 × 2.9%
- = $14,694 + $5356.30
- = $20,050.30
How Self-Employment Tax Is Calculated If the Taxpayer Has Both Wages and Self-Employment Income
By law, the employer must withhold employment taxes from the wages paid to employees. Therefore, if a taxpayer has both wages and self-employment income, then the amount due on the self-employment income can be determined by the following procedure:
- If Wages + Self-Employment Income ≤ Social Security Wage Base, then Self-Employment Tax = Self-Employment Income × 92.35% × 15.3%.
- If Wages > Social Security Wage Base, then Self-Employment Tax = Self-Employment Income × 92.35% × 2 .9%
- Else Self-Employment Tax = Lesser of [(Social Security Wage Base – Wages) or SE Income] × 92.35% × SS Tax Rate (12.4%) + Total Income from Earnings × 92.35% × 2.9%
|2015 Social Security Wage Base||$118,500|
|Self-Employment Income Subject to Self-Employment Tax||$73,880||= Self-Employment Income × 92.35%|
|Social Security Tax Rate||12.4%|
|Medicare Tax Rate||2.9%|
|Social Security Taxable Self-Employment Income||$58,500||= Lesser of (Social Security Wage Base – Wages) or Self-Employment Taxable Income|
|Social Security Tax on Income Below Base||$7,254||= Social Security Taxable Self-Employment Income × Social Security Tax Rate|
|Medicare Tax on Self-Employment Income||$2,143||= Self-Employment Taxable Income × Medicare Tax Rate|
|Total Self-Employment Tax||$9,397|
|Employer-Equivalent Deduction of Self-Employment Tax from Gross Income on Form 1040|
|Social Security Tax Deduction||$4,323||= Self-Employment Income Subject to Social Security Tax × 50%|
|Medicare Tax Deduction||$1,071||= 1/2 of Medicare Tax|
|Total Deduction from Gross Income||$5,395|
In 2013, a new Additional Medicare Tax of 0.9% was added to those taxpayers with incomes above the following threshold amounts:
- $250,000, married filing jointly;
- $125,000, married filing separately;
- $200,000 for all others.
Employers are required to withhold the tax for any payments in excess of $200,000 to an employee during the calendar year, regardless of the filing status of the employee.
- For 2011 and 2012, the employee portion of the Social Security tax was reduced by 2% to 5.65%, for a total SS tax rate of 10.4% instead of 12.4%. Therefore, the self-employed could deduct 57.51% of the self-employment tax instead of just 50%, because the deductible employer portion was a larger percentage of the tax. For more information, see Self-Employment Tax for 2011 and 2012.