How Does Self-Employment Tax Work?

The first year of running a business or a side job is often the year of the surprise tax bill. Employees see social security and Medicare taken out of every paycheck, with the employer paying a matching share. When you work for yourself, you pay both halves, through self-employment tax. Farmers pay it on farm profit too. This answer explains how it works and how a CPA helps you plan for it.

Who has to pay it?

According to the IRS, you must file Schedule SE and pay self-employment tax if your net earnings from self-employment were $400 or more. Net earnings means profit, not sales: income from your business or farm minus the expenses that go with it. It applies to sole proprietors, independent contractors and members of partnerships who are active in the business, and to farmers reporting on Schedule F.

What is the rate?

Part	Rate	Notes
Social security	12.4%	Applies up to an annual earnings limit that changes each year
Medicare	2.9%	No earnings limit
Total	15.3%	Figured on Schedule SE
Additional Medicare tax	0.9%	Only above income thresholds, for example $200,000 for single filers

The social security limit counts your wages and self-employment earnings together. If you also have a job with high wages, part of your self-employment income may be above the limit. Your CPA will check the current year’s figure.

Is any of it deductible?

Yes. The IRS lets you deduct the employer-equivalent portion of self-employment tax when figuring adjusted gross income. This does not reduce the self-employment tax itself, but it lowers the income on which your income tax is figured.

How is it paid during the year?

There is no employer to withhold it. Self-employment tax is paid along with income tax through estimated payments, or covered by extra withholding from a spouse’s or your own job. Missing them can lead to an underpayment penalty. Farmers who qualify under the two-thirds rule have a simpler schedule, described in When Do Farmers Pay Estimated Tax?. California does not have a separate self-employment tax, but it does expect state estimated payments on the same income; see When Are California Estimated Tax Payments Due?.

A simple way to set money aside

Many self-employed people move a fixed share of every payment they receive into a separate savings account for taxes. The right share depends on your total income, deductions and state tax, so ask your CPA to suggest one after your first year’s return. Revisit it whenever your income changes a lot.

What changes if I form an LLC?

A single-member LLC is usually treated like a sole proprietorship for federal tax, so self-employment tax generally still applies to its profit. California charges every LLC an $800 annual tax on top of that, explained in What Does a California LLC Owe Each Year?. Other structures, such as an S corporation election, change how owners are paid and taxed and come with their own costs and filings. This is exactly the kind of decision to make with a CPA rather than from a website.

Questions to ask your CPA

• How much should I set aside from each payment?
• Which expenses can I deduct, and what records do you need for them?
• Should I make estimated payments, and how much each time, federal and state?
• Is my business structure still right for my income?
• Do I need a seller’s permit or any other registration? See Do I Need a Seller’s Permit in California?.

A worked example, without real numbers

Imagine a mobile mechanic in Los Banos who invoices customers through the year. Their Schedule C starts with total receipts, subtracts parts, fuel, insurance, tools and other business expenses, and arrives at net profit. Self-employment tax is figured on Schedule SE from that profit, after a small adjustment built into the form. Half of the self-employment tax is then deducted when figuring adjusted gross income, and income tax is figured on the rest of the return as usual.

The same steps apply to a farmer, starting from Schedule F instead. If the mechanic also earns wages from a part-time job, the social security part of self-employment tax stops once wages and self-employment earnings together reach the year’s limit. That is why your CPA asks for every wage statement, even for small jobs.

Records that matter most

Because self-employment tax is figured on profit, every legitimate expense you can document lowers it. Keep invoices, receipts, mileage logs and bank statements for the business separate from personal ones. How Long Should I Keep Tax and Business Records? covers how long.