How Social Security Works for the Self-Employed

When you're hired and work for a company, your employer takes Social Security taxes out of each of your paychecks and sends the money to the Internal Revenue Service (IRS). But things operate a little differently for people who are self-employed.

If you fall into this category, keep reading to learn how to calculate the Social Security taxes that you'll owe.

Social Security Taxes

When You're an Employee of a Company

If you work for someone other than yourself, Social Security taxes are deducted from your paycheck by your employer. Your Social Security tax rate for 2023 (and 2024) is 6.2%. The cap on taxable income is $160,200 in 2023 and $168,600 in 2024.

So, in 2023 if your annual salary is $160,200 or more, the amount that you'll pay to Social Security is $9,932.40 ($160,200 x .062). In 2024, if your annual salary is $168,600 or more, the amount you'll pay to Social Security will be $10,453.20 ($168,600 x .062). These amounts represent the most an employed worker will pay in social security taxes.

Importantly, your company also pays that 6.2% amount each year on your behalf. It reports your Social Security wages to the government. When you retire or become disabled, the government uses your history of Social Security wages and tax credits to calculate the benefit payments that you’ll receive.

When You’re Self-Employed

When you're self-employed, you're considered both the employee and the employer and you are responsible for withholding 12.4% in Social Security taxes from your earnings. In other words, you contribute both the employer's portion of Social Security (6.2%) and your own portion (6.2%). If you are self-employed and have net earnings of $400 or less, you won’t owe Social Security taxes.

Instead of withholding Social Security taxes from each paycheck—many self-employed people don't get regular paychecks—you pay all the Social Security taxes on your net earnings when you file your annual federal income tax return.

Use IRS Schedule SE: Self-Employment Tax to report your business's net profit or loss as calculated on Schedule C. The federal government uses this information to calculate the Social Security benefits you'll be entitled to down the road.

Tax Deductions Can Reduce the Burden

It may seem like you're getting the short end of the stick when you're self-employed because you have to pay both the employee and the employer portions of the tax. But that isn't necessarily true.

First of all, if you are self-employed, your Social Security taxes are based on your net income. On Schedule SE, you multiply your business’ net profit or loss (as calculated on Schedule C) by 92.35% before calculating how much self-employment tax you owe.

If your Schedule C profit were $100,000, you’d only pay the 12.4% combined employee and employer Social Security tax on $92,350. Instead of paying $12,400, you’d pay $11,451.40. This tax deduction would save you $948.60.

The employer portion of $11,451.40, or $5,725.70, is considered a business expense and can reduce your tax liability.

You report it on line 15 of Schedule 1: Additional Income and Adjustments to Income, which you sum in line 26 and transfer to line 10 of Form 1040, marked total income. This business expense alone would reduce your taxable earnings to $94,274.30, which you enter on line 10 of Form 1040 as adjusted gross income (AGI).

Your total amount of self-employment tax, $11,451.40, is reported on line 4 of Schedule 2: Additional Taxes. You then report any other taxes on the same form, total them, and list that total on line 18.

In our example, there are no other taxes, so that amount is still $11,451.40. This is then entered on line 23 of page 2 of Form 1040, marked “Other taxes, including self-employment tax, from Schedule 2, line 21.”

Of course, you also have to pay regular income tax on your profit.

Minimizing Taxes Minimizes Benefits

Besides the Social Security tax deductions you can take when you're self-employed, many business expenses can reduce your tax liability.

"Business expenses reduce your overall tax, which ultimately lowers your Social Security taxes. Business tax deductions are a way of minimizing self-employment tax and Social Security taxes," says Carlos Dias Jr., founder and managing partner of Dias Wealth LLC in Lake Mary, Florida.

However, keep in mind that the Social Security benefits that you'll receive in the future are based in part on your taxable earnings. So lowering your income with deductions can work against you.

The more deductions that you have, the lower your Schedule C income. Lowering your Schedule C income reduces how much federal, state, and local income tax you owe.

This lower amount becomes part of your Social Security earnings history and means you may receive lower benefits in retirement compared to what you'd receive if you didn't take those deductions.

Lower Taxes Now or Maximum Benefits Later

Should you skip some or all of the business tax deductions you’re entitled to to increase your future Social Security benefit? Maybe. The answer is complicated because lower-earning business people could gain more in the future than their higher-earning counterparts due to how Social Security retirement benefits are calculated.

Benefits Are Based on Your 35 Highest Income Years

Another critical factor is where your Schedule C earnings fall compared to your previous years’ earnings. If you have a full 35-year career behind you and you’re not earning nearly as much in your current self-employed pursuits, it makes sense to take all the deductions you can, as your Social Security benefits will be calculated based on your 35 highest-earning years.

But if you’re currently in the high-earning part of your career, a higher Schedule C income can help you get higher Social Security benefits later. Unless you enjoy complex math problems or have a top-notch accountant, it’s probably not worth the headache to figure out whether you’ll earn more in future Social Security benefits than you’d save by claiming all the deductions you can today.

Of course, suppose you’re on the cusp of not having enough Schedule C income to give you the work credits you need to qualify for Social Security. In that case, it is worth foregoing some deductions to make sure that you qualify for future benefits.

Take Deductions and Invest the Savings

We don't know what Social Security benefit payments will look like in the future (many people expect them to be lower due to growing underfunding). So, one strategy is to go with the sure thing and take the lower tax liability today.

After all, one way to lower your tax liability is to take money out of your business and put it in one of the available retirement plans for the self-employed. That's money you'll have a lot more control over.

"The great thing about Social Security is you cannot access it until retirement age," says Kevin Michels, CFP, EA, financial planner and president of Medicus Wealth Planning.

"You can't make early withdrawals, [but] you can't skip payments, and you are guaranteed a benefit," Michels adds. "However, you have only a small say in the future legislation of Social Security and how it will be affected by the mismanagement of government funds."

Michels continues:

If you have trouble saving for retirement already, then paying [as much as allowed] into Social Security may be the better option. If you are confident you can stick to a savings plan, invest wisely, and not touch your savings until retirement, it may be a better idea to minimize what you pay into Social Security and take more responsibility for your retirement.

If You Fail to File

If you don’t file a tax return reporting your self-employment income, you have a limited time to file a return and still get credit with the Social Security Administration (SSA) for your work time and income.

You must file the return within three years, three months, and 15 days after the tax year for which you earned the income for which you want credit.

That means that, for example, if you didn’t file a return reporting your 2019 self-employment income, you’d have had until April 15, 2023, to correct it. However, this grace period doesn’t exempt you from any penalties and back taxes you may owe due to filing late.

Threshold Amounts

As referred to earlier, you don’t owe Social Security taxes on the portion of your wages that exceed a certain earnings threshold. The wage index for 2023 is $160,200 ($168,600 in 2024). That means that you don’t owe Social Security taxes on any earnings above that amount.

Let’s say that your 2023 annual earnings were $162,200. The tax rate of 12.4% would be applied to the first $160,200 but not the $2,000 above that.

This annual cap on Social Security taxes applies to both self-employed workers and employees who work for someone else.

Qualifying for Social Security Benefits

Anyone born in 1929 or later needs 40 Social Security work credits, the equivalent of 10 years of work, to qualify for Social Security benefits. You earn one credit for every quarter that you earn at least $1,640 in 2023 ($1,730 in 2024). The number changes annually.

Even if your business isn’t particularly successful, or you only work part-time or occasionally, it’s not difficult to earn the Social Security credits you need. Should your earnings fall below this threshold or your business have a loss, there are some alternative ways to earn Social Security credits. These optional methods may increase the amount of self-employment tax you owe, but they’ll help you get the work credits you need.

Your eventual benefit payments take your earnings into account. If you never earned much money from a lifetime of self-employment, don’t count on getting a large Social Security check in retirement.

Also, specific categories of earnings don’t count toward Social Security for most people. These include stock dividends, loan interest, and real estate income. You don’t pay Social Security taxes on this income, and it isn’t used to calculate your future benefits.

The exception is if your business operates in one of these areas where this doesn't apply. Self-employed stockbrokers, for example, do count stock dividends toward their Social Security earnings.

The Bottom Line

The qualifications for Social Security are the same, whether you’re self-employed or work for someone else. Self-employed individuals earn Social Security work credits the same way employees do and qualify for benefits based on their work credits and earnings. However, self-employed workers pay the full 12.4% tax rate where those employed by others pay only 6.2%.

If you work for yourself, deductions you claim on Schedule C can lower your taxable income. That can decrease your Social Security taxes in the present but potentially lower your Social Security benefits later.