Self Employment Tax Research: 50% Off?

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Let me preface this by saying that I am not anywhere near an expert on taxes. I haven’t even itemized deductions before, since I don’t have any mortgage interest to get me over that standard deduction hump. Thus, I’m just writing what I think I’m reading, and tax gurus can correct me.

I’m trying to learn more about self-employment tax. Since you’re not splitting your Social Security Tax with your employer (you’re the employer), you get to pay 15.3% tax on your income. This is in addition to your federal, state, and local income tax. You do get to deduct half of your 15.3% tax from your net earnings, since “regularly” employed people don’t pay tax on the part paid by their employer either. Still, let’s see how much out of every gross $100 I make ends up in my pocket. This simplification assumes no business expenses.

$100 gross income = $92.35 in net income subject to income tax.

My marginal tax brackets (already here after wife’s income): 25% Federal, 9% State/Local

Social Security Tax = 15.3% of $100 = $15.30
Federal Tax = 25% of $92.35 = $23.09
State/Local Tax = 9% of $92.35 = $8.31
Out of $100, I am left with $53.30. 50% off sale!

Ouch. Now, I know that I am really only paying about 8% more in taxes that I would have in my old job, but I think my mind just treats it differently because I’m thinking of it as “extra” income. I know that doesn’t make any real sense, but knowing that if I charge $500 for something, I’ll only get $266, somehow changes whether I feel it is worth the effort.

There are tons of other stuff I want to learn about next. I’m going to take every single allowable tax deduction and business expense known to man, reduce my liabilities by perhaps forming an LLC/S-Corp/C-Corp, getting a Tax ID, maybe a fictitious DBA business name, getting a business checking account, getting a business credit card (although I guess I already have one), getting a PO Box, solo 401ks, and more. I welcome all self-employed people to bury me with advice! =D

Sources: IRS Tax form Schedule SE, Social Security Website

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  1. You get to deduct your state and local taxes off your federal taxes. I assume all my taxes are going to one third, then I add another 4% for the extra FICA. (You get to write off half of it, which is how I got 4%) I also have to pay NYC unincorporated tax, which doesn’t apply to you. Figure your tax rate will be around 40%. If you aren’t going to make a significant amount of money don’t bother with the fancy tax IDs like LLC. It costs over 1k to set up and you’ll have to pay a tax for the license each year. I think mine was $400 one year, fixed no matter how much you earn. Though you get to write off all these fees as business expenses. Go with the sole prioritorship.

  2. Man oh man, I can be here for days on end with advice on what to do and especially what NOT do.

    I’ll add more later but just want to point out that your figures are not far off and this is precisely why I said figure out what someone would get doing that job as an employee and then double it” as a comment in your last post. Freelancing, even part time, is not for the weak or unorganized. But with your attention to detail, you have a good start. Maybe I’ll make a quickie post on my site of steps I went through and why.

  3. nyc – Can I still deduct state and local taxes off my federal taxes if I don’t itemize? I thought not.

    ceo – I look forward to reading about your thoughts, and I’m sure others will too.

  4. Unfortunately, you can only deduct state and local taxes if you itemize…

  5. Yup itemize. I pay my accountant about $1k a year to do my taxes. Get yourself a good accountant and set up your books correctly. You’ll need to pay estimated quarterly taxes which I’m working on this week.

  6. Sorry didn’t realize that your standard deduction is better, I’ve never been in that situation before. Taxes are extremely high here.

  7. The best thing I’ve done is set up an LLC and a SEP-IRA for my partners and myself. All the income flows through to your 1040 where you pay SE taxes. With the SEP we can deduct about 25% of income, up to $42k per year, pre tax. Depending on the income levels, other retirement plans might be a better match.

    The best part is that I can fully fund my SEP and still max out my 401k with my “day” job – all pretax dollars.

  8. Yep, it’s depressing. And don’t forget, if you want to spend any of that money you earned (after income taxes), you’ll need to pay sales tax on whatever you purchase.

  9. I’m looking for tax advice. My boyfriend and I realized that our taxes this year promise to be a bit less amazingly simple and easy than they were in past years, and I’m wondering what sort of tax situation a person has to have in order to make it worth the money it would cost to go and have a tax person do our taxes. And basically, where to go to get cheap, good tax advice. ’cause I surely cannot afford to have an accountant.

  10. Amanda: Can you provide some more details. I think it depends on how comfortable a person is with taxes and finances. For most situations a good tax program would do the job. If your situation is complex and the dolars figures are high, then an accountant might be needed.

  11. Sales tax, property tax, social security (that I’m never gonna see), alternative min tax, death tax. It’s just not worth it, sit back and stop working is the best advice.

  12. Jonathan, I want to point out a few things on SE tax here:

    1. You pay “zero” SE tax if your net earnings from self-employment is less than $400 (actually it’s $433 due to the way SE tax is calculated but you get the picture!:)

    2. SE tax is imposed on NET earnings from self-employment, not gross! In other words, you can deduct related business expenses from your gross income from self-employment before you figure your SE tax. THAT explains why some professionals (doctors/lawyers) make only about $30,000 from their practice a year!!

    3. If you want to save on SE tax in California, you may consider setting up an S corporation (as income from an S corp is not subject to SE tax, unlike net earnings from a partnership or LLC). But beware of the 1.5% tax imposed on California S corp. or the annual $800 California minimum tax. The $800 minimum tax is similar to the $400 mentioned by NYC Money, i.e., every year you either pay the $800 or the 1.5% tax, whichever is higher for the year.

    Also, as mentioned earlier, it’s not really worthwhile getting into all the fancy tax-saving schemes unless it’s really absolutely necessary (based on objective, income level, tax saving, etc).

    Remember, tax should only be “a” factor (not “the” factor) in doing business!

  13. “And basically, where to go to get cheap, good tax advice. ’cause I surely cannot afford to have an accountant.”

    You get what you pay for…. (in some instances) You and your ‘boyfriend’ can not file married if you’re not married. Therefore you have to really worry about your own taxes and let him worry about his own. If you want specific help, it would be more beneficial to say what some things you are having problems with. H&R is not something I recommend at all – lots of screwing up, discontentment, and inexperience floating around.

    I’ll admit, living in NH is nice, no sales tax. High property taxes equal it out, but again that’s deductable and usually if you have that – you are automatically filing an itemized deduction. (Mortgage payments and Property taxes usually put you above automatically.)

    Things to think about are:

    Home office use — USE THIS WITH CAUTION. Home office is defined as a set area only used for business. Having this option raises your chances for an audit, but if you remain decent and truthful to what you take – no worries.

    Milage – If you travel to and from somewhere while on a “self-employment” job (or subcontractor) you can deduct 40.5 cents per mile up to about september and 48.5 after till the end of the year.

    Itemized deductions – Schedule A:

    Charities – Charity mile rates increased, I want to say to about 37 cents per mile – however I am not quoting that rate.

    Unreimbursed Employment expenses – you need to have a minimum of 2% of your AGI before it becomes deductable. But if you do a lot of purchasing of things required but not reimbursed it will help. (Tools for the worktrade)

  14. Why open a PO box when you have a perfectly good mailing address with your home?

  15. NYC’s comment about net income is a good point. the SE will come on that, not your full $100 gross.

    Even if you don’t itemize, look at filing the long 1040 and pay attention to the bottom of the form’s first page. Self-employed people get some help here. Note that you get to deduct 1/2 of the SE tax you paid here.

    Also did you pay for your own health insurance? Deduct that here. That’s a huge one for me.

    And don’t forget opening a self-employed retirmeent account. Several options here — Keough, SEP-IRA, SE401(k. You can deduct the contributions here. You also might be elgibile for the retirement saver’s credit (line 51 on the second page of form 1040).

    Hang in there. Working for yourself has many benefits not available when working for “the man!”

  16. Damgoodbuildr says

    As a general contractor in San Diego Ca. …. I work my ass off for half the year, then use the rest of my profits to sustain myself for the other half that’s slow or no work at all…where do I get the money to pay my taxes each year? I am pretty much screwed …That’s it.

    And on top of it all, Mrs. Jones is calling me back to her job I finished last year to fix a little microscopic blemish in her wall that she just now noticed…sigh.

    Keep your day job through a recession.

  17. Hi im X. Lee I on a venture to see if its cheaper to pay my taxes Quarterly Or Annually?. What are some simple Straight forward ideas for self employed?. Im not working right now and would like some help about this because its something ive been tracking for 5 years now including the job market. Thats why im in persue of this.

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