Understanding Self-Employment Taxes
If you’re a self-employed individual or own a growing, unincorporated small business, understanding self-employment (SE) taxes is crucial. The SE tax serves as the mechanism through which Social Security and Medicare contributions are collected. While these taxes fund important social programs, they can result in hefty bills for business owners.
SE Tax Basics: What You Need to Know
For 2024, the self-employment tax rate is 15.3% on the first $168,600 of net SE income. This rate includes:
- 12.4% for Social Security.
- 2.9% for Medicare.
For 2025, the threshold increases to $176,100. However, once your income exceeds these limits, the 12.4% Social Security portion no longer applies, leaving only the 2.9% Medicare tax in effect.
How to Calculate Your SE Tax
Follow these steps to determine your SE tax bill:
- Take your net income from self-employed activities (commonly listed on Schedule C of Form 1040).
- Multiply that income by 0.9235 to get your net SE income.
- If your income is $168,600 or less (2024):
- Multiply the amount by 15.3%.
- If your income exceeds $168,600:
- Apply 12.4% to $168,600 for Social Security.
- Apply 2.9% to the total income for Medicare.
- Add these two amounts for your final SE tax.
Example:
In 2024, if your net SE income is $200,000, your SE tax calculation would be:
- 12.4% × $168,600 = $20,906 (Social Security).
- 2.9% × $200,000 = $5,800 (Medicare).
- Total SE Tax = $26,706.
The Rising Cost of SE Taxes
SE taxes aren’t just high now; they’re projected to increase. As Social Security tax ceilings rise with inflation, small business owners may face growing tax burdens.
Here are the Social Security tax ceilings projected by the Social Security Administration (SSA):
- 2026: $181,800
- 2027: $188,100
- 2028: $195,900
- 2029: $204,000
- 2030: $213,600
- 2031: $222,900
- 2032: $232,500
- 2033: $242,700
A Disconnect Between Taxes and Benefits
While the Social Security tax ceiling increases yearly, the growth in Social Security benefits does not keep pace. For example:
- The 2024 tax ceiling rose by 5.24% compared to 2023.
- However, Social Security benefit payments only increased by 3.2% during the same period.
This discrepancy occurs because different inflation measures are used:
- Tax ceilings are based on wage inflation.
- Benefit increases are tied to general inflation rates.
A Smart Tax-Saving Strategy: S Corporations
If the weight of self-employment taxes feels overwhelming, there’s a potential solution: restructuring your business as an S corporation.
Here’s how it works:
- Pay yourself a reasonable salary.
- Distribute the remaining corporate profits to yourself as dividends.
This strategy ensures that only your salary is subject to Social Security and Medicare taxes. Dividends, on the other hand, are not subject to SE taxes, potentially saving you thousands each year.
Take Control of Your SE Taxes
Self-employment taxes are a reality for business owners, but careful planning can help you manage and reduce your tax burden. Whether you’re exploring restructuring options like an S corporation or want help calculating your SE tax obligations, expert advice is just a call away.
Contact Us Today!
Our team specializes in tax strategies for small business owners and self-employed individuals. Let us help you keep more of what you earn. By understanding SE taxes and implementing strategies to manage them, you can focus on growing your business without unnecessary financial stress.
