The Self-Employment Tax
Employees and their employers each pay 7.65% of wages in FICA taxes: 6.2% for Social Security (up to the wage base, $168,600 in 2024) and 1.45% for Medicare. Self-employed individuals — sole proprietors, single-member LLC owners, freelancers, independent contractors — pay both the employee and employer portions, totalling 15.3% on net self-employment income up to the Social Security wage base, plus 2.9% Medicare on amounts above it. An additional 0.9% Medicare surtax applies on self-employment income above $200,000 (single). The self-employment tax is calculated on Schedule SE and added to income tax on Form 1040.
Deductions Available to the Self-Employed
The tax code provides several offsetting benefits to the self-employed. Half of the self-employment tax is deductible above-the-line — reducing AGI, not just taxable income. This deduction partially compensates for the "employer share" that employees' employers pay on their behalf. Self-employed individuals can also deduct 100% of health insurance premiums paid for themselves, their spouse, and dependents as an above-the-line deduction — a significant benefit unavailable to employees who purchase individual coverage. Home office deductions are available if a portion of the home is used exclusively and regularly for business. Vehicle expenses, professional development, and ordinary business expenses reduce net self-employment income before the SE tax is even calculated.
The Qualified Business Income Deduction
The Tax Cuts and Jobs Act of 2017 created IRC Section 199A, which allows most pass-through business owners (sole proprietors, S corporation shareholders, partners in partnerships) to deduct up to 20% of their Qualified Business Income (QBI) from taxable income. For a sole proprietor with $100,000 of business profit, the QBI deduction may reduce taxable income by up to $20,000 — effectively reducing the federal income tax rate on business profits from 22% to 17.6%. The deduction is scheduled to expire after December 31, 2025, when TCJA provisions sunset unless Congress acts. Significant restrictions apply: above certain income thresholds ($191,950 single / $383,900 MFJ in 2024), "specified service trades or businesses" — which include law, consulting, financial services, accounting, and medicine — face phase-outs and limitations that can reduce or eliminate the deduction.
S Corporation Election as a Tax Strategy
Self-employed individuals with consistent profits sometimes elect S corporation status to reduce self-employment taxes. In an S corporation, the owner is both a shareholder and an employee. The IRS requires the owner to pay themselves a "reasonable salary" — subject to full FICA taxes. Remaining profits distributed as S corporation dividends (not wages) are not subject to the 15.3% self-employment tax, only income tax. Example: a sole proprietor with $200,000 of profit pays SE tax on the full amount. As an S corporation paying a $100,000 salary and $100,000 in distributions, FICA applies only to the $100,000 salary — potentially saving $10,000–$15,000 in SE taxes annually. The IRS scrutinises unreasonably low salaries from S corporations, and the strategy requires a separate business bank account, payroll processing, and additional tax filings (Form 1120-S) — the compliance cost must be weighed against the tax savings.