Self-Employment Taxes Explained: Strategies to Manage and Reduce Your Tax Burden

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:

1. Take your net income from self-employed activities (commonly listed on Schedule C of Form 1040).
2. Multiply that income by 0.9235 to get your net SE income.
3. If your income is $168,600 or less (2024):
   • Multiply the amount by 15.3%.
4. 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:

1. Pay yourself a reasonable salary.
2. 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.

Ken Botwinick, CPA Partner, CPA

Ken Botwinick, CPA is a Partner with Botwinick & Company, LLC and has been with the firm for more than 25 years. Ken specializes in providing accounting, tax, and business consulting services to dental and medical practices. He established the firm’s dental practice and is a sought-after lecturer at dental continuing education programs. Ken has his “finger on the pulse of the dental industry,” and with comprehensive experience in ownership transitions, he assists clients in the healthcare industry to reach their professional and financial aspirations and goals. In addition to accounting, tax, and consulting engagements with dental and healthcare practices, Ken provides a wide range of services to medium-sized and closely held businesses. Over the past decade, Ken has also played an integral role in the success of numerous technology start-up clients in Europe and Israel. By providing specialized tax guidance and back-office support, Ken has supported many entities as they transitioned from one-person organizations to 100-person venture-capital-backed enterprises. Ken’s client service philosophy is to take a “team approach” to engagements and provides clients with highly effective strategies and solutions. The result is low employee turnover and quality client service at the highest level. The firm’s staff and management collaborate and work closely together, and the clients reap the benefits. Ken also fosters continuing education at the firm to keep the partners and the staff up to date on new legislative changes, including emerging economic stimulus tax credits.

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