Self-Employment Tax
Self-employment tax is the 15.3% Social Security and Medicare tax you pay on your net business earnings when you work for yourself, covering both the employer and employee halves that a regular paycheck would split.
A W-2 employee and their employer each cover 7.65% of Social Security and Medicare. When you're self-employed, you're both parties, so you eat the full 15.3% yourself. That breaks into two pieces with very different ceilings. The 12.4% Social Security portion stops at $184,500 of earnings in 2026 (up from $176,100 in 2025) — past that, no more Social Security tax. The 2.9% Medicare portion has no ceiling at all; it follows every dollar you make, and once you clear $200,000 single ($250,000 married filing jointly) an extra 0.9% gets bolted on.
You figure the tax on Schedule SE, and it sits on top of your income tax rather than replacing any of it. One break softens the blow: you deduct the employer-equivalent half, roughly 7.65% of net earnings, above the line, which trims your adjusted gross income. Worth knowing that the tax only bites on 92.35% of your net profit, not the whole thing — that 7.65% haircut is baked into the formula before you ever multiply by 15.3%.
This applies to sole proprietors, single-member LLC owners, and general partners. It does not apply to S-Corp distributions, which is the entire point of the S-Corp election. Run your business as an S-Corp and you pay payroll tax only on the salary you draw, not on the profit you take as a distribution. The catch is the IRS requires that salary to be "reasonable" for the work you actually do — lowball it and you're inviting an audit.
The math usually starts working once net income clears roughly $60,000, because the election carries real costs: payroll filings, a separate return, and bookkeeping that an unincorporated freelancer skips. Below that, the savings often don't outrun the overhead. Above it, the gap widens fast, and the bigger the spread between a defensible salary and total profit, the more you keep.
One more wrinkle from the July 2025 tax law (OBBBA): the 20% qualified business income deduction under Section 199A is now permanent, with no 2025 sunset. That deduction excludes W-2 wages from QBI, so an S-Corp owner is balancing a lower salary (less payroll tax) against the fact that salary doesn't qualify for the 20% break. It's a real trade-off worth modeling with your tax advisor, not eyeballing.
Practical Example
David nets $150,000 of self-employment income in 2026. SE tax applies to 92.35% of that, or $138,525 — below the $184,500 Social Security cap, so the full 15.3% hits: $138,525 x 15.3% = about $21,194. He deducts roughly half (~$10,597) above the line against income tax. Now elect S-Corp status and pay himself a $70,000 salary. Payroll tax on $70,000 is 15.3% = $10,710; the remaining $80,000 comes out as a distribution with no SE tax. Savings: about $10,484 a year — before netting out the added cost of payroll and a corporate return.