Self-Employment Tax

Self-employment tax is the tax imposed by section 1401 of the Internal Revenue Code on a person's self-employment income. It has two components: 12.4 percent for old-age, survivors and disability insurance, and 2.9 percent for hospital insurance, giving the familiar combined rate of 15.3 percent. It exists because an employee's Social Security and Medicare contributions are split between the employee and the employer, and a person working for themselves has no employer to pay the other half. Self-employment tax collects both halves in one charge, which is why the rate is roughly double what appears on an employee's payslip.

It is computed on Schedule SE and it is entirely separate from income tax. The same business profit is charged twice, once under this section and once as ordinary income, which is the single most common surprise for someone in their first year of self-employment.

The 92.35 percent factor has a derivation, and knowing it prevents the commonest arithmetic error here. Section 1402(a)(12) provides a deduction, taken inside the computation of net earnings, equal to the taxpayer's net earnings multiplied by one-half of the combined section 1401(a) and 1401(b) rates, excluding the additional Medicare tax. Half of 15.3 percent is 7.65 percent, so net earnings come out at 100 percent minus 7.65 percent, which is 92.35 percent of profit. The purpose is parity: an employee's wages are set after the employer's share has already been paid, and this adjustment approximates the same treatment for someone paying both shares.

That factor and the deductible half are two different adjustments, and conflating them is how the arithmetic goes wrong by roughly half. The first reduces the base before the tax is computed. The second, at section 164(f)(1), is an income tax deduction for one-half of the section 1401 tax after it has been computed, and section 164(f)(2) treats it as attributable to a trade or business, which makes it an above-the-line deduction available whether or not the taxpayer itemises. Note the exclusion written into section 164(f)(1): the additional Medicare tax under section 1401(b)(2) is expressly left out, so the deductible half covers only the 15.3 percent component.

The two halves of the tax behave differently once income rises. The Social Security component applies only to net earnings up to the contribution and benefit base, $184,500 for 2026. Section 1402(b)(1) then adds a rule that catches anyone with both a job and a side business: the ceiling is reduced by the wages already paid to that person during the year, so employment wages consume the room first and only what is left is exposed to the Social Security portion of self-employment tax. The Medicare component has no ceiling and applies to every dollar of net earnings.

A third layer sits on top for higher earners. Section 1401(b)(2) imposes an additional 0.9 percent on self-employment income above $250,000 on a joint return, $125,000 for a married taxpayer filing separately, and $200,000 in any other case, and those thresholds are reduced by wages taken into account for the equivalent employment tax. Two features distinguish it from the rest. There is no employer-side match, so a self-employed person pays the same 0.9 percent an employee does rather than double. And the thresholds are statutory and have never been indexed, so the share of taxpayers reaching them grows every year by inflation alone.

The $400 threshold is the most misstated figure in this area. Section 1402(b)(2) excludes net earnings from self-employment income "if such net earnings for the taxable year are less than $400", and because section 1402(a)(12) puts the 92.35 percent factor inside net earnings, the profit that trips the threshold is not $400. Schedule SE makes the order explicit: line 4a is line 3 multiplied by 0.9235, and line 4c instructs the filer to stop if the result is under $400. At $433 of profit, net earnings are $399.88 and no tax is owed. At $434 they are $400.80 and the tax applies. The distinction is easy to lose, because the threshold is commonly described as $400 of profit, which is the figure before the 92.35% step rather than after it. The $400 is also not indexed, and has not moved since it was written.

Schedule SE follows the statute step by step, and each step has to be taken in order.

1. Start with net profit from Schedule C, or the equivalent figure from a partnership.

2. Multiply by 92.35 percent to get net earnings from self-employment.

3. Stop if that figure is under $400. No self-employment tax is due and no Schedule SE is filed.

4. Apply 12.4 percent to net earnings up to the year's Social Security ceiling, reduced by any wages already paid to you during the year.

5. Apply 2.9 percent to all net earnings, with no ceiling, and add 0.9 percent on anything above the relevant threshold.

6. Deduct half of the resulting tax, excluding the 0.9 percent component, as an above-the-line deduction on the income tax return.

A hypothetical example, with the income kept below the Social Security ceiling so that no ceiling arithmetic is involved. Idris has $50,000 of net profit from a freelance design business and no wages from any employer. His net earnings from self-employment are 92.35 percent of that, or $46,175. His self-employment tax is 15.3 percent of $46,175, which is $7,064.78. That breaks into $5,725.70 of Social Security tax, being 12.4 percent, and $1,339.08 of Medicare tax, being 2.9 percent. He then deducts half of the total, $3,532.39, on his income tax return, and that deduction is available whether or not he itemises. The deduction reduces the income tax he pays on the same profit; it does not reduce the self-employment tax itself.

What the tax buys, and where it is fair

• Paying it is what earns Social Security and Medicare coverage, so a self-employed person builds the same retirement, disability and survivor credits an employee does.
• The 92.35 percent factor and the section 164(f) deduction together approximate the treatment an employee gets, so the self-employed are not charged on income an employee would never have been taxed on.
• The Social Security ceiling means the rate on additional earnings drops substantially once a high earner passes it.
• Half the tax is deductible above the line, so the benefit is available without itemising.

Limits and cautions

• Nothing is withheld, so the whole amount has to be funded through estimated payments during the year or found in April.
• It applies from the first dollar of net earnings once the small threshold is passed, with no standard deduction equivalent and no bracket structure.
• The additional 0.9 percent thresholds are not indexed, so they reach more people every year without any change in the law.
• The deductible half reduces income tax only, so a taxpayer in a low income tax bracket gets very little back from it.
• A person with both a job and a business has to track the wage ceiling across both, and payroll systems cannot do it for them.