When people leave a W-2 job to start a business, consult, or freelance, one of the first surprises is self employment tax. As an employee, half of Social Security and Medicare taxes came out of each paycheck and the employer quietly paid the other half. Once you are self-employed, you are generally responsible for both halves. That can make the tax bill on business profit noticeably larger than people expect. If you want help understanding your self employment tax and planning around it, a complimentary, no-obligation wealth and tax review is a good place to start.
This guide explains what self employment tax is, who generally pays it, how it is calculated in broad terms, and the planning considerations that business owners commonly review.
What Self Employment Tax Is
Self employment tax is the Social Security and Medicare tax paid by people who work for themselves. It funds the same programs that payroll taxes fund for employees, and it generally earns you credit toward future Social Security benefits. It is calculated on Schedule SE and reported on your individual return.
The tax has two parts. The Social Security portion applies to net earnings up to an annual wage base that is adjusted each year. The Medicare portion applies to all net earnings, and an additional Medicare tax may apply at higher income levels. Because these figures change, it helps to check current amounts each year rather than rely on old numbers.
Who Pays It
Self employment tax generally applies to:
Sole proprietors and single-member LLC owners who report business income on their individual return
General partners and many LLC members, on their share of partnership earnings from a trade or business
Independent contractors, freelancers, and gig workers
Some farmers and ministers, under special rules
There is a small net earnings threshold below which the tax generally does not apply. Limited partners and certain LLC members may be treated differently, an area where the rules continue to be clarified through guidance and court cases.
How the Calculation Works in General Terms
Self employment tax is generally calculated on net earnings from self-employment, which starts with business profit and applies an adjustment intended to mirror the employer side of payroll taxes. Then, on the income tax side, you may deduct a portion of the self employment tax when calculating adjusted gross income. The result is that self-employed people are treated roughly like employees and employers combined, though the math is not identical.
Self employment tax is separate from income tax. You may owe it even in a year when you owe little or no income tax, which is a common surprise for new business owners with modest profit.
How Entity Choice Affects It
The way a business is organized can change how self employment tax applies. An S corporation is the most commonly discussed example. Owners who work in an S corporation are paid a reasonable salary, which is subject to payroll taxes, and may receive the remaining profit as distributions, which are generally not subject to self employment tax.
That structure is not automatically better. It brings payroll administration, a separate business return, state filing requirements, and a requirement that salary be reasonable for the work performed. Setting salary too low to avoid payroll taxes can draw scrutiny. Our guide to how to pay yourself as a business owner covers the factors involved.
Planning Considerations
Several planning areas interact with self employment tax:
Retirement plan contributions. Plans such as a SEP IRA or Solo 401(k) are tied to self-employment earnings. Contributions may reduce income tax, though generally not self employment tax. See our guide on SEP IRA vs Solo 401k.
Health insurance. Self-employed people may be able to deduct health insurance premiums for themselves and their families, subject to rules.
Business expenses. Legitimate business expenses reduce net earnings and therefore self employment tax. Personal expenses run through the business do not.
Estimated payments. Self employment tax is generally paid through quarterly estimated payments along with income tax. Missing them can lead to penalties.
It is also worth remembering the other side of the equation: self employment tax builds your Social Security earnings record. Reducing it may also reduce future benefits, which is a tradeoff to weigh rather than ignore.
Wisconsin Considerations
Wisconsin does not have its own version of self employment tax, but self-employed Wisconsin residents still owe Wisconsin income tax on business profit and generally make state estimated payments. If you work across the border in Minnesota or another state, additional filing requirements may apply.
Building Self Employment Tax Into Your Budget
Many self-employed people set aside a portion of each payment they receive in a separate account for taxes. A consistent habit like this can make quarterly estimates less stressful and reduce the risk of a large balance due in April. Reviewing the set-aside amount midyear, especially after a strong quarter, can keep it aligned with actual results. Year-round tax planning and preparation can help you project the right amount.
Self Employment Tax and Your Future Social Security Benefits
Self employment tax is often viewed only as a cost, but it also builds your Social Security earnings record. Benefits are generally based on your highest earning years, so years with low reported self-employment earnings can affect the benefit you eventually receive. Business owners who reduce self-employment earnings through entity structure or low salaries may also be reducing future benefits.
That does not mean paying more tax is always the right answer. It means the decision has two sides. A business owner with a long earnings history from earlier W-2 work may weigh the tradeoff differently than someone who has been self-employed their entire career. Reviewing your Social Security statement periodically, and comparing projected benefits with your retirement plan, can help you make an informed decision. Our article on Social Security claiming strategies covers how benefits fit into a broader retirement income plan.
Next Steps
Whether you are a consultant in Madison, a contractor in Waunakee, or a growing business owner elsewhere in Wisconsin, understanding self employment tax is a basic part of running a business. The right structure and planning approach depend on your profit, goals, and appetite for administration.
To talk through your situation, request a complimentary, no-obligation wealth and tax review.
Frequently Asked Questions
What is self employment tax?
Self employment tax is the Social Security and Medicare tax paid by self-employed people on their net earnings, generally covering both the employee and employer portions.
Do I pay self employment tax if I have an S corporation?
S corporation owners generally pay payroll taxes on their salary. Distributions of remaining profit are generally not subject to self employment tax, provided salary is reasonable.
Can I deduct self employment tax?
A portion of self employment tax is generally deductible when calculating adjusted gross income.
Do retirement contributions reduce self employment tax?
Retirement contributions generally reduce income tax but not self employment tax for sole proprietors.
How do I pay self employment tax?
It is generally paid through quarterly estimated payments and reconciled on your annual return using Schedule SE.
Compound is a registered investment adviser. Registration does not imply a certain level of skill or training. This article is for informational and educational purposes only and should not be construed as personalized investment, tax, or legal advice. Tax laws are complex and subject to change. Strategies discussed may not be suitable for everyone, and there is no guarantee that any strategy will achieve its objectives or reduce taxes. Investing involves risk, including possible loss of principal. Please consult your tax, legal, and financial professionals before acting on any information in this article. For more information, see Compound's Form ADV, available at adviserinfo.sec.gov.
Information may be generalized or subject to change. Please contact our team for the most current and accurate information.
About Compound Wealth
Many financial decisions involve more than one area of expertise. Compound Wealth provides integrated tax planning, wealth management, accounting, and business transition services so clients can evaluate financial decisions within a broader planning framework. This collaborative approach supports thoughtful conversations across multiple areas of financial life.
