Why Do Self-Employed People Hate the Self-Employment Tax?

For Sole Proprietors, Schedule SE (Self-Employment Tax) is arguably the most hated of all tax forms. The purpose of the form is to calculate the dreaded self-employment tax that all self-employed people must pay. The purpose of this article is to explain the reason for this tax and the resulting hatred.

If you own a small business that is not a partnership, a corporation, or a multi-member limited liability company, your business is probably a Sole Proprietorship. You may not consider yourself to be a "small business owner", but in the eyes of the IRS, a Sole Proprietor is just that. Other titles for this esteemed designation include self-employed, independent contractor, consultant, or freelancer. The end result is the same: you must report your business income and expense on Schedule C, Profit or Loss from Business.

If your profit from that self-employment activity is greater than $433, you must not only pay federal income tax on that profit, you must also pay federal self-employment (SE) tax on that profit. In 2008, if your Schedule C profit is less than $102,000, your SE tax is calculated according to this formula: Net profit x 92.35% x 15.3%. If your Schedule C profit is greater than $102,000, you use the above formula, plus another 2.9% on any profit above $102,000.

So this is the calculation behind the tax. The tax itself is simply the government's way of assessing social security tax (12.4%) and Medicare tax (2.9%) on the Sole Proprietor. When you add 12.4% plus 2.9%, you get 15.3%. And now we get to the heart of the matter: this 15.3% is actually twice as much as an employee would pay for social security and Medicare tax, because an employee only pays 6.2% and 1.45%, for a total of 7.65%. The employer then pays the equivalent 7.65%, and when you add the two, the employee and the employer together pay the same 15.3%. The Sole Proprietor pays it all himself, whereas the employee and employer each pay half.

So now you know why this is known as the "dreaded" SE tax. Why should the self-employed person pay twice as much as the employed person? An answer to that question is beyond of the scope of this article, of course, but at least you understand what is going on, and why Sole Proprietors shake their fists in rage at the mere mention of Schedule SE.