What is self-employment tax?

Self-employment tax is the Social Security and Medicare tax paid by business owners on their business income, equivalent to both the employee and employer portions of FICA. For sole proprietors, partners, and single-member LLC owners, self-employment tax is 15.3% (12.4% Social Security + 2.9% Medicare) on net business income. A consulting firm owner with $200,000 net income pays $30,600 in self-employment tax. S-Corp owners avoid self-employment tax on distributions but pay it on W-2 salary through regular FICA withholding.

Key characteristics of self-employment tax

• Rate: 15.3% on first $160,200 (2023), 2.9% Medicare on amounts above

• Additional Medicare: 0.9% on income over $200,000 (single) or $250,000 (married)

• Calculated on: 92.35% of net self-employment income

• Deduction: 50% of self-employment tax is deductible on Form 1040

• Form: Calculated on Schedule SE, paid with income tax

Why self-employment tax matters for service firms

Self-employment tax is often the most significant tax burden for profitable service firm owners. A sole proprietor with $300,000 net income pays approximately $42,400 in self-employment tax, significantly more than income tax for many. This tax drives S-Corp election decisions: S-Corp owners pay FICA (essentially self-employment tax) only on W-2 salary, not distributions. A $300,000 income split as $120,000 salary and $180,000 distribution saves approximately $27,500 annually in self-employment/FICA tax. Understanding self-employment tax is critical for entity selection, estimated tax planning, and comparing owner compensation strategies.

Example: Self-employment tax calculation and S-Corp savings

Scenario 1: Sole proprietorship

• Net business income: $350,000

Self-employment tax calculation:

• Net earnings for SE tax: $350,000 × 92.35% = $323,225

Social Security portion (12.4%):

• First $160,200: $19,865

Medicare portion (2.9%):

• Full $323,225: $9,373

Additional Medicare (0.9%):

• Amount over $200,000: $123,225 × 0.9% = $1,109

• Total self-employment tax: $30,347

• Deduction: 50% of SE tax deductible = $15,174

Scenario 2: S-Corporation (same $350,000 income)

• Owner W-2 salary: $140,000 (reasonable compensation)

• S-Corp distribution: $210,000

FICA tax on salary:

• Employee portion (7.65%): $10,710

• Employer portion (7.65%): $10,710

• Total FICA: $21,420

Distribution: $210,000 (NO self-employment tax)

Tax savings comparison:

• Sole proprietor SE tax: $30,347

• S-Corp FICA tax: $21,420

• Annual tax savings: $8,927

Additional benefits of S-Corp:

• Employer FICA ($10,710) deductible to S-Corp

• QBI deduction applies to the $210,000 distribution

• No SE tax on distributions provides significant savings

Note: IRS requires 'reasonable compensation' as salary

• Paying a $50,000 salary on a $350,000 income invites an audit

• Safe range: 35-50% of net income as W-2 salary