When you receive a paycheck from an employer, you pay 6.2% of your earnings towards Social Security (up to a maximum of $127,200 of your earnings in 2017) and 1.45% of your earnings towards Medicare. Together, these two components are what is referred to as “FICA”, or the “Federal Insurance Contributions Act.” Your employer is then required to match those amounts. Of course, when you are a sole proprietor or a general partner, YOU are the company. Because of this, you end up having to pay the entire 15.3% (6.2%+6.2%+1.45%+1.45%). You do, however, get to take what you pay for self-employment tax as an income tax deduction (what you owe for federal taxes, a separate component from the self-employment tax). To calculate this deduction, you would multiply your business net income by 92.35% (100% – 6.2% – 1.45%). The result is then multiplied by the self-employment rate of 15.3%. This gives you the self-employment tax you owe. Divide that number by 2, and you arrive at the deduction you can take to lower your adjusted gross income. Here’s an example:
- After expenses, your sole proprietorship net income = $50,000.
- Multiply $50,000 x 92.35% = $46,175.
- Multiply $46,175 x 15.3% = $7,065 (your self-employment tax on $50,000 of net income from the business).
- Divide $7,065 / 2 = $3,532 as the deductible part of your self-employment tax, reported on line 27 of your form 1040.
There are some types of income that are not subject to self-employment tax, which is why it is always best to consult a tax professional before trying to figure out what your self-employment tax will be come tax time.