What it means
When you work for an employer, Social Security and Medicare taxes are shared: you pay one half through your pay slip and your employer pays the other half. If you are self-employed, there is no employer, so the Self-Employment Contributions Act requires you to pay both halves yourself.
That is why freelancers and sole traders often find their tax bill higher than expected. The combined rate has long been 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare, though lawmakers can change the rates.
The Social Security part applies only up to an annual earnings cap that is set each year, while the Medicare part applies to all earnings. Higher earners may owe an extra Medicare tax above certain income thresholds.
The tax is not charged on your full profit. It is applied to 92.35% of your net earnings from self-employment, which is a reduction designed to mirror the fact that an employer's share of payroll tax is not part of an employee's wages.
You normally report it on a separate schedule alongside your income tax return. There is a partial offset.
You can deduct half of the self-employment tax when calculating your income tax, which recognises the employer-equivalent half you paid. Self-employed people also usually make quarterly estimated payments through the year, because no one is withholding the tax for them.
For business owners, the practical lessons are to budget for this tax separately from income tax and to consider how business structure affects it. Partnerships and sole proprietors are generally within its reach, while the treatment of owners in other structures differs, so professional advice is worth having.
Working out the numbers early is the best protection against a nasty surprise. Many self-employed people put aside a fixed percentage of every payment they receive, such as 25% to 30% of profit, to cover both income tax and self-employment tax.
The right share depends on income level, location and deductions, so it should be reviewed each year.
In practice
Real-world examples.
Example
A freelance photographer earns net profit of $60,000 and receives no employer withholding. She calculates her self-employment tax on $55,410, which is 92.35% of the profit. She sets aside the amount each quarter so there is no surprise at filing time.
Example
A rideshare driver treated as an independent contractor earns $30,000 net after expenses. Because nobody withholds payroll tax from the payments, the driver owes the full 15.3% on 92.35% of the profit. The driver adds the amount to quarterly estimated payments.
Example
A partner in a small architecture firm receives a $120,000 share of the profits. The partner pays self-employment tax on the share, applying the Social Security portion only up to the annual cap. The Medicare portion applies to the whole amount.
Formula
Calculation
Self-employment tax = net earnings from self-employment x 92.35% x 15.3%
A freelance designer has net profit of $80,000 for the year, which is assumed to be below the annual Social Security earnings cap. The taxable base is $80,000 x 0.9235 = $73,880. The tax is $73,880 x 0.153 = $11,303.64. Half of that, $5,651.82, can be deducted when working out income tax.Case study
Seen in the real world.
Lumen Consulting is a fictional one-person practice run by Tariq, who left a salaried job and earned $90,000 net in his first year. He assumed his tax would be about the same as before, but he forgot that his former employer had been paying half of his Social Security and Medicare.
At filing time he faced a self-employment tax bill of over $12,000 on top of income tax. This is an illustrative story, but the lesson is real: Tariq now moves a fixed share of every client payment into a separate savings account and pays estimated tax each quarter. He also takes the deduction for half of the self-employment tax.
Tariq also learned that being self-employed meant he had to fund his own retirement and health cover, which made the tax bill feel even heavier. By year two he had priced his services about 15% higher to reflect the true cost of working for himself, and clients accepted the change.
Watch out
Common mistakes.
- Forgetting that self-employed people pay both the employee and employer halves. The tax is 15.3% rather than the 7.65% that employees see on their pay slips.
- Applying the rate to total revenue. It is calculated on net earnings after business expenses, and then reduced to 92.35% of that figure.
- Ignoring quarterly payments. Because nobody withholds the tax, missing estimated payments can lead to penalties.
Questions
People also ask.
What does SECA stand for?
It stands for the Self-Employment Contributions Act, the law that sets out self-employment tax for Social Security and Medicare.
Is any of the self-employment tax deductible?
Yes, half of it can be deducted when calculating income tax, which acts as a partial offset.
Does the Social Security part have a limit?
Yes, it applies only up to an annual earnings cap set each year, while the Medicare part applies to all net earnings.
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