Running your own business is exciting, but it also comes with responsibilities—like managing your self-employment (SE) taxes. If you’re feeling overwhelmed by the numbers, here’s a quick breakdown of how SE taxes work and tips to manage them.
What Is the Self-Employment Tax?
SE tax covers Social Security and Medicare contributions for self-employed individuals, replacing the payroll taxes typically withheld from employees’ paychecks.
- Rate: It’s 15.3% of your net self-employment income.
- 12.4% goes to Social Security (up to a limit).
- 2.9% goes to Medicare (with no limit).
- 2024 Threshold: The 15.3% rate applies to your first $168,600 of net income. Anything above that only gets the 2.9% Medicare rate.
How Do I Calculate My SE Tax?
Here’s a quick formula:
- Take your net business income (usually from Schedule C of Form 1040).
- Multiply it by 0.9235 to adjust for deductions.
- Apply the 15.3% rate up to $168,600, then 2.9% for anything above that.
Example:
If your 2024 net income is $200,000:
- 12.4% × $168,600 = $20,906
- 2.9% × $200,000 = $5,800
Your total SE tax would be $26,706.
That’s a big chunk, but understanding where it goes can help you plan better.
What About Future Increases?
The Social Security tax ceiling rises every year, often faster than inflation. Here are the projected thresholds:
- 2026: $181,800
- 2030: $213,600
- 2033: $242,700
By 2033, you could pay up to $37,133 in SE taxes if your income hits that ceiling.
Is It Fair?
There’s often a mismatch between tax ceiling increases and benefit growth. For example:
- In 2024, the tax ceiling increased by 5.24%, but Social Security benefits rose only 3.2%.
- This is because tax ceilings are tied to wage growth, while benefits use general inflation.
How Can I Manage My SE Taxes?
High SE taxes can take a toll, but there are strategies to reduce the burden. One popular option is transitioning to an S corporation:
- Pay yourself a reasonable salary (subject to Social Security and Medicare taxes).
- Take the rest of the profits as distributions, which avoid SE taxes.
This setup can save you money, but it needs to be done correctly to stay compliant.
Need Help?
Understanding and managing SE taxes can feel overwhelming, but you don’t have to do it alone. If you have questions or want to explore strategies like the S corporation approach, we’re here to help! You can find your local Padgett office here.