Self-Employment Tax

Brand-new business owners are sometimes surprised to find out that in addition to their federal income taxes, they must also pay a significant percentage of their income to the government in the form of SECA taxes.

The Self-Employment Contributions Act (SECA) tax is basically the business owner's version of the FICA tax that employees pay. Like FICA, it is made up of your "contributions" to both the Social Security and Medicare programs. However, the basic tax rate for the self-employed under SECA is 15.30 percent -- twice the 7.65 percent rate that employees must pay on their paychecks as FICA tax -- to reflect the fact that employees and employers pay one-half the FICA tax and employers pay the other half.

Beginning in 2013, a new 0.9 percent Medicare surtax applies to self-employment income exceeding a threshold amount. The threshold amount is based on filing status ($250,000 for joint return, $125,000 for separate, and $200,000 in any other case) and is coordinated with FICA wages. (The corresponding FICA surcharge is borne entirely by the employee; there is no employer match. Presumably, this is why there is no employer-equivalent deduction for self-employment tax purposes.)

Tip

If your income is high enough to be subject to this surtax, consider increasing the amount of your estimated tax payments, in order to avoid a penalty come tax time. Your accountant or advisor should be able to help you decide how much to pay.

What income counts? For starters, you don't have to worry about paying the SECA tax at all if your total business income, from all Schedule Cs combined and from any partnership or S corporation income that is treated as self-employment income, is less than $400. But if your total income is $400 or more, you must file a Schedule SE and pay SECA tax on your entire net business income, including the first $400.

If you are filing jointly and your spouse also files one or more Schedule Cs, each spouse must count his or her own income separately.

Example

You own two small businesses and file two Schedule Cs. Business A had net income of $80,000 and Business B had a net loss of $5,000. Your spouse also operated a business as a sole proprietor, and had net income of $20,000. On Line 12 of your Form 1040, you would report all Schedule C income earned by both you and your spouse: $80,000 + $20,000 - $5,000 = $95,000.

However, for SECA tax purposes, your total net business income would be $80,000 - $5,000 = $75,000. Your spouse's total net income for SECA purposes would be $20,000. You must each file one Schedule SE and attach both of them to your joint Form 1040.

Since it's the net income from your business that is the basis of SECA tax, certain types of income are not included:

interest and dividend income;

income from sales of business property or other assets;

rental income from real estate or personal property, unless generating that income is your core business (e.g., real estate developers or property rental businesses);

and

income from your hobbies.

Farmers. Farmers who file Schedule F with their Form 1040 must include as self-employment income their net income from farming, as shown on Line 36 of their Schedule F.

Some special rules apply to the following:

Once you know what types of income to count, you can: