Hidden Tax of Being Your Own Boss: An Overview of Self-employment Tax

An overview of the “self-employment” tax and it’s impact on your business

When Jenna quit her 9-to-5 to launch her dream consulting business, she felt unstoppable. The freedom, the creativity, the rush of landing her first clients it was everything she hoped for.

What she didn’t expect was a massive tax bill that hit her like a freight train at the end of the year. Jenna hadn’t heard much about self-employment tax. In fact, she thought taxes would be easier now that she wasn’t getting a paycheck anymore. Instead, she found herself facing thousands of dollars in unexpected taxes money she had already spent reinvesting in her business.

Sound familiar?

Here’s the thing most business owners aren’t told when they take that brave first step into entrepreneurship: Self-employment tax is real, it’s expensive, and it can catch you completely off-guard if you don’t plan for it.

But here’s the good news:

At Make Taxes Fair, we believe that complexity should never be a weapon used against entrepreneurs.

The tax code can be understood and navigated with efficiency.

And with the right strategies, you can pay less and grow your wealth confidently.

In this guide, we’ll break down:

• What self-employment tax actually is,

• When it applies (and when it doesn't),

• How it’s calculated,

• And most importantly, how to legitimately protect yourself while building the business you love.

Entrepreneurs are incredibly brave! You took a bold step when you chose to bet on yourself to step into the arena of self-employment. 

Let’s make sure you’re not letting the IRS take a bigger piece of your dream than they should.

What Is Self-Employment Tax?

If you’ve ever had a traditional job where taxes were taken out of your paycheck automatically, you probably never thought much about Social Security or Medicare taxes.

Your employer handled half of the burden for you, behind the scenes, without you lifting a finger.

But when you're self-employed, YOU are both the employer and the employee.

Self-employment tax is the way you fund your Social Security and Medicare benefits as a business owner. It’s made up of:

• 12.4% for Social Security, and

• 2.9% for Medicare, totaling 15.3% on your net earnings​.

In plain English:

It’s not a “penalty” for being self-employed; it's simply paying your share into the same system W-2 employees use. It’s just that you are now responsible for the whole tab and not just the employee portion.

Who Has to Pay Self-Employment Tax?

You’re generally subject to self-employment tax if you:

• Run your own business as a sole proprietor (even a side hustle),

• Are an independent contractor or freelancer,

• Are a general partner in a partnership,

• Or a member of an LLC taxed as a disregarded entity (unless you elected S-Corp taxation)​​.

And here's the critical number:

If your net earnings are $400 or more in a year, you must file a tax return and pay self-employment tax​.

Many new business owners are shocked to realize that even if they only made a few thousand dollars freelancing on the side, the IRS still expects a cut.

Self-Employment Tax vs. Income Tax: They’re Different

It’s important to know:

• Self-employment tax covers Social Security and Medicare only.

• Income tax is completely separate and based on your taxable income after deductions and credits.

You’ll usually owe both self-employment tax and income tax.

Understanding the difference is key to proactive planning, not just reactive pain in April.

In the next section, we’ll show you exactly how self-employment tax works, including the numbers you need to watch and a simple formula you can use to stay ahead all year long.

Because when you understand the rules, you can use them to your advantage.

How Self-Employment Tax Works

Now that you know what self-employment tax is, let’s break down how it actually operates because the more clearly you understand the mechanics, the better you can plan, save, and keep more of your hard-earned money.

The Double Tax Burden: Why It Feels So Heavy

If you’ve ever worked as a W-2 employee, then you may have noticed payroll taxes like social security and medicare being deducted from your pay. However, what you see as a W-2 employee is only half the payroll taxes come out of your paycheck. The other half comes from your employer.

When you’re self-employed, you pay both sides:

• 12.4% for Social Security,

• 2.9% for Medicare, which totals 15.3%​.

It can feel like you are paying twice what a W-2 employee does because in the eyes of the IRS, you're both boss and worker.

A quick example:

• If your net self-employment income is $60,000:

• You owe approximately $9,180 in self-employment tax alone ($60,000 × 92.35% × 15.3%).

(We'll explain the "92.35%" quirk next.)

Why Only 92.35% of Your Earnings Are Taxed

Here’s a nice little bonus:

When you calculate self-employment tax, you only apply the 15.3% rate to 92.35% of your net earnings, not the full 100%​.

The IRS lets you deduct the "employer half" (roughly 7.65%) when figuring the tax, since you’re paying both parts.

Formula:

Net Self-Employment Income × 92.35% = Self Employment Taxable Income

Income Caps and Additional Medicare Tax

There’s a limit to how much of your income gets hit by Social Security tax:

• In 2025, that ceiling is $176,100​.

• After that, you no longer owe Social Security tax, but you still pay Medicare tax on every dollar above that.

But before you celebrate that “tax break,” you need to know that on top of your social security tax and medicare tax, if your total income (including wages and self-employment income) exceeds:

• $200,000 (single),

• $250,000 (married filing jointly), then you’ll owe an extra 0.9% Medicare tax on the income above those thresholds​.

You Also Get a Tax Deduction (Sort Of)

Even though you're stuck paying the full 15.3%, the IRS lets you deduct half of your self-employment tax when you calculate your adjusted gross income (AGI).

Key point: This deduction doesn't reduce your self-employment tax it just reduces your taxable income for income tax purposes.

Example:

• If you owe $9,180 in SE tax, you can deduct $4,590 when figuring your income taxes.

It’s like getting a small win on the way to fighting the bigger battle.

In the next section, we’ll show you why understanding self-employment tax matters beyond just staying legal, especially how it connects to future Social Security benefits and immediate tax savings strategies. Because knowing the rules isn’t enough, you deserve to win the game.

Why Understanding Self-Employment Tax Matters

You might be thinking:
"Okay, I get it. Self-employment tax is a thing. But why should I really care beyond just writing a check to the IRS?"

Here’s why:  Understanding self-employment tax can be the difference between thriving financially and constantly feeling like you’re treading water.

Let’s dig into the real reasons this matters:

1. Avoiding Ugly Tax Surprises

Many first-year entrepreneurs find out the hard way:

When you don’t plan for self-employment tax, the IRS doesn’t send a friendly reminder. They send a bill, plus interest and penalties if you’re late.

By learning how SE tax works, you can:

• Set aside the right amount throughout the year,

• Pay quarterly estimated taxes,

• Or better yet take proactive steps to implement a tax savings plan to pay less to the government legitimately!

2. Protecting Your Cash Flow (And Your Business)

Cash flow is the lifeblood of your business.

Unexpected tax bills can cripple that flow. when you:

• Take proactive steps to reduce your taxes then you can, 

• Build tax payments into your budgeting,

• Plan for both SE tax and income tax,

Taking these steps allows you to protect your ability to:

• Invest in growth,

• Pay yourself confidently,

• Handle slow seasons without panic.

In other words understanding self-employment tax isn’t just about compliance, it can be the difference between your business just surviving or really thriving!

3. Building Your Future Social Security and Medicare Benefits

While we don’t like taxes per se we do have to admit that taxes have their purpose.

The self-employment taxes you pay is meant to fund your:

• Social Security retirement benefits, and

• Medicare health coverage later in life.

Every dollar you report and pay into the system is counted toward your future benefits.

Without enough "quarters" paid into Social Security, you could:

• Miss out on retirement income,

• Have gaps in your Medicare eligibility,

• Face higher out-of-pocket healthcare costs as you age.

This isn’t just about today, it’s about protecting the "future you."

As a side note, we’ve encountered many grieving spouses who recently lost their significant other tragically to accident or illness and are now facing raising a young family on their own. One case stands out where the husband had worked “under the table” his entire life and had never reported his income for taxes. While he saved money on taxes, he left his wife and 3 young children with no ability to claim any sort of survivor benefit from the Social Security system. 

So, while we are not a fan of taxes and always actively look to reduce your tax bill, there are cases where taxes can and do serve a purpose and provide a benefit.

4. Unlocking Smart Tax Strategies

When you fully understand how self-employment tax works, you can unlock opportunities to:

• Choose the right legal structure (like electing S Corp status to save big​​),

• Maximize deductions legally​​,

• Optimize retirement plans that slash taxable income​,

• And deploy many other tax strategies to counterbalance the weight of the self-employment tax to pay less​.

Knowledge isn’t just power it’s savings.

In the next section, we’ll show you how to actually calculate your self-employment tax step-by-step and introduce a simple system you can use year-round to stay ahead, not behind.

Because once you see the numbers clearly, you can finally start playing offense instead of defense.

How to Calculate and Pay Self-Employment Tax

Understanding why self-employment tax matters is step one.
Now, let’s roll up our sleeves and walk through how to actually calculate it, without getting lost in IRS forms and fine print.

Step 1: Calculate Your Net Earnings

Start with your business income:

• Add up all the money you earn, whether it’s client payments, sales revenue, or service fees.

Then subtract your business expenses:

• Think: software, supplies, marketing, home office, professional services, mileage, and any other legitimate business costs​.

The Formula is:

Gross Income − Business Expenses = Net Earnings

(If you haven’t already, now’s the time to set up organized bookkeeping. Good records aren't just for taxes, they're for peace of mind​.)

Step 2: Multiply Net Earnings by 92.35%

Here’s the quirk we mentioned earlier:

• You only owe SE tax on 92.35% of your net earnings​.

The Formula is:

Net Earnings × 0.9235 = Self-Employment Taxable Income

This adjustment reflects the fact that employees don’t pay self-employment tax on their employer’s portion, so you shouldn’t either.

Step 3: Apply the Self-Employment Tax Rate (15.3%)

Now take your taxable income and multiply it by 15.3% to find your total self-employment tax owed.

The Formula is:

SE Taxable Income × 15.3% = Self-Employment Tax Due

Real-World Example:

Let’s say Jenna (from our earlier story) had $80,000 in gross income and $20,000 in deductible business expenses:

1. Gross Income $80,000 − Business Expenses $20,000 = $60,000 Net Earnings
2. Net Earnings $60,000 × 92.35% = $55,410 Self-Employment Taxable Income
3. Self Employment Taxable Income $55,410 × 15.3% = $8,474 Self-Employment Tax Owed

Jenna owes approximately $8,474 in self-employment tax for the year (and remember, this is on top of her regular income tax).

Step 4: Don’t Forget About Additional Medicare Tax (If Applicable)

If your total income (wages + self-employment earnings) exceeds:

• $200,000 (single),

• $250,000 (married filing jointly), you’ll also owe an extra 0.9% on the amount over that threshold​.

It pays to be proactive. Even if you don’t hit those thresholds now, keep an eye on them as your business grows so that you can mitigate the damage from a rising tax bill that accompanies growing income.

How (and When) to Pay Self-Employment Tax

Unlike traditional employees who have taxes withheld automatically, self-employed individuals are expected to pay as they go.

Here’s what it means when someone says they “file quarterly taxes”:

• Quarterly Estimated Tax Payments:
  Pay estimated taxes 4 times per year using Form 1040-ES.

• Annual Filing:
  File your total taxes, including self-employment tax, using your Form 1040 and Schedule SE at the end of the year​​.

The General Due Dates for Estimated Payments are:

• April 15

• June 15

• September 15

• January 15 (of the following year)

Missing these deadlines can lead to penalties and interest, so setting calendar reminders or automating your payments is a simple move that can save you big headaches later.

Shortcut Tip: The "Set Aside 25-30%" Rule

When you're unsure how much to save, a good general rule for many entrepreneurs is:
Set aside 25–30% of your net income for taxes.

This covers both your income tax and your self-employment tax, keeping you prepared for filing season and avoiding unpleasant surprises.

In the next section, we’ll talk about something exciting: How you can legally minimize self-employment tax because paying your fair share doesn't mean paying a penny more than necessary. It’s time to move from defense to offense. Let’s go!

How to Minimize Self-Employment Tax (Legally and Smartly)

Let’s be clear: At Make Taxes Fair, we never believe in cutting corners.

But we absolutely believe in using every legal strategy available to you to minimize your tax burden and keep more of your hard-earned profits where they belong: in your pocket and your bank account.

Here’s how smart entrepreneurs legally trim their self-employment tax bill:

1. Choose the Right Legal Structure

Elect S Corporation Status

Once your business profits consistently exceed about $60,000–$70,000 a year, it’s often smart to consider becoming an S Corporation​​.

Here’s why:

• As an S Corp owner, you must pay yourself a reasonable salary (which is subject to payroll taxes).

• BUT the profits above your salary are treated as distributions, not subject to self-employment tax.

Example:

• Jenna’s consulting business earns $100,000.

• She pays herself a reasonable salary of $42,000 (subject to SE tax).

• The remaining $58,000 in distributions escapes SE tax entirely!

Result: Thousands in legal tax savings every year!

AND THIS IS A VERY IMPORTANT NOTE:
Always document your salary carefully. Underpaying yourself can trigger IRS scrutiny. We actually discuss more of this topic in our articles around “Reasonable Compensation” and what it means to pay an S-Corporation owner a “reasonable salary”.

2. Maximize Every Business Deduction

Every dollar you legitimately deduct from your business income:

• Lowers your net earnings,

• Which reduces the amount subject to self-employment tax​.

Common deductions include:

• Home office expenses

• Business mileage

• Supplies, software, and equipment

• Marketing and advertising costs

• Professional education and certifications

• Health insurance premiums (if eligible)

If you already have an S-Corporation, you can use an Accountable Plan to reimburse yourself for home office, travel, and other expenses tax-free​​.

3. Open a Retirement Plan

Contributing to a Solo 401(k) or a SEP IRA doesn’t just build your future, it slashes today’s taxable income​.

This is a true Win-Win!
You’re saving for retirement and lowering your current-year self-employment tax and income tax liabilities.

Example:

• Jenna contributes $20,000 to a Solo 401(k).

• That $20,000 isn’t counted in her net earnings calculation, meaning she saves taxes now and grows her nest egg tax-deferred.

4. Hire (the Right Way) and Capture Credits

If you move from being a solo operator to hiring employees:

• You’ll shift part of your business tax burden onto payroll (FICA) instead of purely self-employment taxes.

Plus, by hiring eligible employees, you can unlock valuable credits like the Work Opportunity Tax Credit (WOTC)​​ directly reducing your income taxes.

Warning: Misclassifying employees as independent contractors is a big audit risk. Always classify correctly to protect your business​.

5. Set Up Quarterly Estimated Payments

Paying quarterly doesn’t directly reduce your tax rate.
But it:

• Avoids IRS penalties and interest,

• Keeps your cash flow steady,

• Makes tax time far less stressful.

And by making estimated payments (after your efforts to reduce your tax bill) you will be able to avoid what we call “big check syndrome” where you feel like you’re constantly writing big checks to the government and others. Escape the big check syndrome to capture peace of mind.

Legally minimizing your self-employment tax isn’t just about saving money today.

It’s about strategic financial independence, keeping more of what you earn to reinvest, grow, and live the life you dreamed of when you started your business.

Next up, we’ll cover something that every smart entrepreneur needs to know:

How to protect yourself from audits and mistakes when dealing with self-employment tax.

Because it’s not just what you deduct, it’s how you document and defend it that matters.

Audit Protection Tips for Self-Employment Tax

The IRS doesn't randomly throw darts when selecting businesses to audit. They look for red flags, and self-employed individuals often light up their radar like fireworks.

The good news is when you set up the right systems, stay organized, and document properly, you can operate confidently, knowing you’re audit-ready.

Here’s how to build a fortress around your business:

1. Keep Pristine Records

Audit protection starts with documentation.

What to keep:

• Bank statements

• Credit card statements

• Receipts for every expense over $75 (and even many smaller ones)

• Mileage logs for business driving​

• Home office measurements and expenses (if claiming home office deductions)

• Income records (invoices, 1099s, payment processor reports)

Digitize your records using accounting software, cloud storage, or apps that track receipts and mileage.

Think of your documentation like a seatbelt: You hope to never need it but if something goes wrong, it can save you from major harm.

2. Separate Business and Personal Finances

Comingling your personal and business funds is a classic IRS red flag. While this may be allowed if you are a sole proprietor filing a Schedule C for your taxes, it is absolutely prohibited if you are an LLC or Corporation.

Take Action To Implement These Simple Fixes:

• Open a separate business bank account.

• Use a business credit card (even a basic one).

• Always pay yourself through formal draws or payroll, not random personal withdrawals.

Why does all this matters? Clear separation makes it easier to prove legitimate business expenses and harder for the IRS to challenge your deductions.

3. Document Your Business Purpose

For every major deduction, you should be able to answer the question:
"How does this expense help me earn more business income?"

Some practical examples:

• Taking a client to lunch? Save the receipt and jot a note about the meeting.

• Buying a laptop? Document how it's used in your business.

• Traveling for work? Keep your conference registration and travel agenda.

Remember: Intent + Documentation = Protection.

4. Use an Accountable Plan (If You’re an S Corporation)

If you’ve elected S Corporation status (or plan to), setting up an Accountable Plan is critical​​.

The Benefits:

• You can reimburse yourself for business expenses tax-free.

• The business gets deductions.

• You avoid having reimbursements treated as taxable income.

To implement an Accountable Plan you absolutely must have these elements:

• Written plan in place

• Clear expense documentation

• Reimbursements made within 60 days

Accountable Plans are a hidden gem that save you money and protect you during an audit.

You can find more about those HERE in this free training that we have provided at MakeTaxesFair.com. 

5. Watch Out for Common Self-Employment Audit Triggers

Avoid these high-risk behaviors:

• Reporting little or no income year after year without a legitimate reason

• Claiming massive deductions that don’t match your income

• Failing to issue 1099s to contractors you paid over $600​

• Misclassifying workers to avoid payroll taxes​

Remember, the goal isn’t to avoid claiming legitimate deductions. It’s to document them so well that if the IRS ever asks, you simply smile and hand them everything they need.

Building audit protection into your business isn’t about fear it’s about confidence.

Confidence that you're keeping more of your money... ethically, legally, and defensibly.

Friends don’t let friends overpay the government or go into audits unprepared.

Next we’ll break down common mistakes business owners make with self-employment tax and how to avoid them.

Because knowing what NOT to do is just as important as knowing the right moves.

Common Mistakes to Avoid

Even savvy business owners can trip up when it comes to self-employment tax.

The good news? Knowing the most common pitfalls can help you steer clear and stay in control of your financial future.

Here’s what to watch for:

1. Not Paying Quarterly Estimated Taxes

One of the biggest mistakes?
Waiting until April 15 to think about your tax bill.

Reality check: Self-employed individuals are expected to pay taxes as they earn income, not just at the end of the year.

If you don’t make quarterly estimated payments, you could owe:

• Late payment penalties (even if you pay everything by April),

• Interest charges that quietly drain your profits.

The Solution:

• Use IRS Form 1040-ES to calculate and pay estimated taxes four times a year.

• Set reminders or automate payments so you never miss a deadline.

2. Misclassifying Employees as Independent Contractors

Hiring help is exciting, but mislabeling workers is a huge audit red flag​.

Reminder:

• Employees: You control how, when, and where they work. You must withhold and pay employment taxes.

• Independent contractors: They control their own work process. You issue a 1099-NEC if you pay them $600+.

Misclassification penalties can include:

• Back taxes,

• Penalties,

• Interest,

• And even personal liability for unpaid payroll taxes.

Rule of thumb: When in doubt, treat them as employees or get expert help to classify properly.

3. Forgetting About the Additional Medicare Tax

If your total income crosses:

• $200,000 (single),

• $250,000 (married filing jointly), you owe an extra 0.9% in Medicare taxes​.

Many business owners miss this layer of tax, especially if they earn W-2 wages plus self-employment income.

Tip: Track total household income, not just business profits, to avoid underpaying.

4. Taking Deductions Without Proper Documentation

You might be legally entitled to deduct expenses...
but without good records, it’s like it never happened.

Common mistakes:

• Tossing receipts into a shoebox,

• Forgetting to document the business purpose,

• Not tracking mileage or home office use properly.

The Solution: Treat documentation as part of your everyday business systems, not a scramble at tax time​​.

5. Setting the Wrong Salary in an S Corporation

If you elect S Corporation status to save on self-employment taxes (smart move!), you must pay yourself a reasonable salary​.

What’s reasonable? It depends on:

• Industry standards,

• Your role,

• Your experience,

• How much profit the business generates.

Common mistake: Paying yourself too little to dodge taxes. This can trigger audits, penalties, and forced reclassification by the IRS.

Tip: Document how you determined your salary, and update it as your business grows.

6. Relying Too Much on "Happy Historian" CPAs

Most CPAs are great at filing taxes… but many aren’t trained or focused on proactive tax strategy​​.

If you only hear from your CPA once a year, you’re missing massive savings opportunities.

The Solution:
Partner with a strategist who:

• Helps you plan throughout the year,

• Focuses on proactive savings (like Make Taxes Fair’s CLEAR EDGE Framework),

• Understands how business owners can legally minimize taxes, not just survive tax season.

You don’t need to be perfect, you just need to be intentional.
Avoiding these mistakes sets you up to win bigger, keep more, and worry less.

Action Plan: What to Do Next

Knowledge is powerful, but applied knowledge is what changes your business and your life.

Now that you understand self-employment tax, you’re standing at a crossroads.
You can let the system surprise you or you can take control, protect your profits, and build real financial freedom.

Here’s exactly what to do next:

Step 1: Estimate Your Self-Employment Tax Now

Don’t wait until tax season.

• Calculate your expected net earnings for the year. 
• Apply the 92.35% adjustment. 
• Multiply by 15.3% to estimate your SE tax. 
• Add estimated income taxes to plan for the full picture.

Bonus Tip: Set aside 25–30% of your net earnings into a separate savings account for taxes. Think of it as paying yourself and protecting yourself.

Step 2: Set Up Quarterly Estimated Tax Payments

Mark your calendar for these payment dates:

• April 15

• June 15

• September 15

• January 15 (of the following year)

Automate reminders or payments if possible to stay on track.

Peace of mind is worth it.

Step 3: Evaluate Your Legal Structure

If you’re making $40,000+ in profits consistently,
Talk to a tax strategist about whether an S Corporation election makes sense for you​.

This one move alone could save you thousands in self-employment taxes.

Step 4: Maximize Deductions and Set Up Systems

Review your expenses. Make sure you’re capturing:

• Home office,

• Mileage,

• Equipment,

• Business travel,

• Continuing education,

• Health insurance premiums (if eligible).

• Set up an Accountable Plan if you're running an S Corp​​.
• Use bookkeeping software (or a simple spreadsheet) to stay organized every month​.
• Save receipts, track mileage, and document the business purpose of major expenses.

Step 5: Protect Yourself from Audits

• Keep clean records. 
• Separate business and personal finances. 
• Stay proactive, not reactive.

Remember: Audit protection isn’t about hiding. It’s about building a bulletproof business that stands up proudly to scrutiny.

Step 6: Partner with a Tax Strategist, Not Just a Tax Preparer

• Find a tax professional who thinks like an entrepreneur, not just a historian​​.

• Look for someone who:

• Helps you plan year-round,

• Educates you,

• Focuses on proactive, ethical strategies,

• Helps you build wealth, not just file paperwork.

Final Thoughts

Now it's time to take action. If you have any questions, reach out and start a conversation

Self-employment tax doesn’t have to be a mystery. It doesn’t have to be scary. And it certainly doesn’t have to be a burden that steals your hard-earned success.

When you understand the rules and use them to your advantage, you reclaim your power.
You protect your profits. You build the business (and life) you dreamed of when you chose to bet on yourself.

Friends don’t let friends overpay the government.

And starting today, you’re no longer just reacting. You’re building. You’re protecting. You’re winning. Ready to start a conversation? Reach out and let us know!