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- How Self-Employment Tax Works: A Simple Guide for Business Owners
How Self-Employment Tax Works: A Simple Guide for Business Owners
As your own boss, you're responsible for paying self-employment tax. Who needs to pay? How do you calculate? Smart ways to reduce what you owe?
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Key Highlights:
Who Needs To Pays Self-Employment Tax?
What Is the Self-Employment Tax Calculation?
Example: Self-Employment Tax Calculation
Which Business Tax Structures Does Self-Employment Tax Apply To?
Strategies to Minimize Self-Employment Tax
If you work for yourself and earn $400 or more in net income per year, you must pay self-employment tax. This applies to:
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Traditional employees don't pay self-employment tax because their employers withhold Social Security (6.2%) and Medicare (1.45%) taxes from their paychecks and pay these amounts on their behalf. When you're self-employed, you're considered both the employer and employee for tax purposes, and essentially, pay more tax!
What Is the Self-Employment Tax Calculation?
Self-employment tax is a 15.3% tax that covers your Social Security and Medicare contributions. Unlike employees who split this tax with their employers, self-employed individuals pay the full amount themselves. The calculation has a few simple steps:
Calculate your net earnings (business income minus expenses)
Multiply your net earnings by 92.35% (this adjustment accounts for the employer portion)
Apply the 15.3% tax rate to this amount (12.4% for Social Security, 2.9% for Medicare)
For 2024, the Social Security portion only applies to the first $168,600 of earnings
Also you can deduct half of your self-employment tax on your income tax return
Example: Self-Employment Tax Calculation
Marcus earns $75,000 from his graphic design business in 2024
His business expenses total $15,000
Net earnings: $75,000 - $15,000 = $60,000
Taxable amount: $60,000 × 92.35% = $55,410
Self-employment tax: $55,410 × 15.3% = $8,478
Eligible deduction for tax return: $8,478 × 50% = $4,239
Note: The $8,478 amount in self-employment tax does not include Federal tax and or State taxes.
Which Business Tax Structures Does Self-Employment Tax Apply To?
Not all business structures handle self-employment taxes the same way. Here's how different business types are affected:
Business Structure | Self-Employment Tax | How It Works |
Sole Proprietorship | Yes | All net earnings are subject to self-employment tax |
Partnership | Yes | Each partner pays SE tax on their share of partnership income |
LLC (Single-Member) | Yes | Treated like a sole proprietorship for tax purposes |
LLC (Multi-Member) | Yes | Treated like a partnership by default |
S Corporation | Partial | Only salary is subject to employment taxes; distributions are not |
C Corporation | No | Owners pay regular employment taxes on salary only |
The way your business is structured can significantly impact how much self-employment tax you pay. Many small business owners choose to form an S Corporation as they grow to potentially reduce their self-employment tax burden.
Strategies to Minimize Self-Employment Tax
While you must pay your fair share of taxes, there are legal ways to reduce your self-employment tax burden:
1. Track All Business Expenses
Since self-employment tax is calculated on your net earnings (income minus expenses), every legitimate business expense you track and deduct lowers your taxable income. Common deductions include:
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2. Claim the Home Office Deduction
If you use part of your home regularly and exclusively for business, you may qualify for the home office deduction. This can include a portion of your rent/mortgage, utilities, internet, and home maintenance costs.
Self-employed individuals can deduct 100% of health insurance premiums for themselves and their families as an adjustment to income, which reduces net earnings subject to self-employment tax.
4. Contribute to Retirement Accounts
Contributions to retirement accounts like a SEP IRA, SIMPLE IRA, or Solo 401(k) can significantly reduce your taxable income. These accounts have higher contribution limits for self-employed individuals than traditional IRAs.
5. Consider Changing Your Business Structure
As your business grows, forming an S Corporation might help reduce self-employment taxes. With an S Corp, you can pay yourself a reasonable salary (subject to employment taxes) and take additional income as distributions (not subject to self-employment tax).
For more information on tax savings when converting to an S-Corp click below:
Important: Always consult with a tax professional before changing your business structure. The decision involves many factors beyond just self-employment tax.
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