How much is your self-employment tax?

H23 BB00934850 * ...my $100 'star note'Self-employment tax can eat up a huge chunk of your income (up to 13.3%). 

Here is how to calculate self-employment tax for a self-employed individual operating as a sole proprietorship.
The two components of self-employment tax are social security tax and medicare tax:
In 2012, Social security tax is 10.4% of the first $106,800 in your business’ net income. If you earned wages or tips (aside from your self-employment income), then you pay social security tax only on the first $106,800 of your combined wages, tips, and business net income.
Medicare tax is 2.9% of all of your business’ income.
A few simple examples to illustrate:
Joe earned $60,000 in net income from his business, and nothing else.  This is subject to Social security tax (10.4%) and Medicare tax (2.9%).
$60,000 x (10.4% + 2.9%) = $7,980
Mary earned $150,000 in wages and $60,000 from her business.  The employee’s share of social security tax will be deducted from her paycheck, meeting the $106,800 maximum.  The $60,000 earned from her business will be subject only to Medicare tax (2.9%).
$60,000 x 2.9% = $1,740

Pat earned $75,000 in wages and $60,000 from their business.  The employee’s share of social security tax will again be deducted from her $75,000 paycheck.  Because the $106,800 maximum has not been met, then the remaining business income, up to the maximum ($106,800 – 75,000) is subject to both Social security tax and Medicare tax.  Business income exceeding $106,800 will be subject only to Medicare tax.
$106,800 – $75,000 = $31,800 subject to both Social security & Medicare
$31,800 x (10.4% + 2.9%) = $4,229.
$60,000 – $31,800 = $28,200 subject only to Medicare
$28,200 x 2.9% = $818
$4,229 + $818 = $5,047.
Self-employment tax is regressive: the more money you make, the lower the rate you pay.  If you have no additional job, then you will pay the highest rate of taxes on your self-employment income ($7,980, or 13.3%) whereas if you have a well-paying $150,000/year job, then you will pay the lowest rate of taxes on your self-employment income (just $1,740, or 2.9%).
As if this isn’t sufficiently complicated, 50% of your self-employment tax is deductible for purposes of figuring your Adjusted Net Income (but not as a business expense).
Legislation alert: If a bill to renew the current rate reduction is not passed, then Social security will pop back up to 12.4% on January 1, 2013, for a combined rate self-employment tax rate of 15.3%.  This 2% tax increase will also hit employees’ wages.
Be careful to plan for self-employment tax when computing your estimated taxes.
More information on the IRS’ website.
[Image: H23 BB00934850 * …my $100 ‘star note’ by TheAlieness GiselaGiardino²³, on Flickr]

About Mark P. Holtzman

Chair of Accounting Department at Seton Hall University. PhD from The University of Texas at Austin. Worked at Deloitte's New York Office. BSBA from Hofstra University.

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  1. Payroll tax cut continues « Accountinator - February 27, 2012

    […] Self-employed taxpayers will enjoy a similar savings in self-employment tax. […]

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