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.