What is Self-employment (SE) Tax?

While income tax is paid on any kind of taxable income, self-employment (SE) tax is paid only by people who work for themselves. SE tax is social security and Medicare tax for self-employeds and is paid on a self-employed’s net earnings.

Net earnings – think of it as net profit. It's what you have left after subtracting all business expenses from your gross self-employed income.

You must pay self-employment tax if net earnings from self-employment are $400 or more. The SE tax rate is 15.3% and is made up of two components: 12.4% social security tax plus 2.9% Medicare tax.

Social security benefits are available to self-employed persons just as they are to wage earners. Your payments of SE tax contribute to your coverage under the social security system which provides you with retirement, disability, and survivor benefits.

Medicare coverage provides hospital insurance benefits.

There is a cap on the amount of earned income on which you must pay social security tax. The cap for 2009 and 2010 is $106,800.

That means that you do not pay social security tax on income over $106,800. If you were to make $106,800 as an employee and also have an indie venture with a $20,000 profit, you would pay no social security tax on the $20,000 profit because you had already paid the maximum social security tax for 2009 or 2010 via withholding on your wages.

If you had a job and were also self-employed you would pay social security tax on both wages and profit until you met the $106,800 limit.

If you earn $106,800 in 2009 or 2010 you will pay the same amount of social security tax as Max Millionaire who earns $1,000,000. Hmmmm... do you see an opportunity here for filling the social security coffer?

There is no cap on Medicare tax. You pay 2.9% Medicare tax on all earned income.

{revised 1/31/10}