Self-employment tax is the largest tax many freelancers, consultants, and small business owners pay - and the least understood. At 15.3% on the first $184,500 of net self-employment income (2026) and 2.9% above that, SE tax often exceeds income tax for lower-income self-employed individuals. The S-corporation election is the primary legal strategy to reduce SE tax on high-income self-employment, but it requires a reasonable salary and carries ongoing compliance costs. Understanding the mechanics determines whether the election actually saves money.
Self-employment tax is the self-employed person's equivalent of FICA - the combined Social Security and Medicare taxes that employers and employees split. A self-employed person pays both the employer and employee share.
The deduction for half of SE tax (IRC §164(f)) reduces AGI - not just taxable income - by half the total SE tax paid. This partially offsets the burden but does not eliminate it. At $150,000 of net self-employment income, the SE tax is approximately $20,565 and the deduction saves about $3,804 at the 37% rate - meaning the net SE tax cost is roughly $16,761, in addition to income tax.
S-corporation distributions (amounts paid to owner-shareholders above their reasonable W-2 salary) are not subject to SE tax or FICA. Only the W-2 salary portion is subject to payroll taxes. This creates the primary SE tax planning opportunity: elect S-corp status, pay a reasonable salary (subject to payroll taxes), and take the remaining profit as a distribution (not subject to FICA).
The IRS requires S-corp owner-employees to pay themselves a reasonable salary for services actually performed. This is the most heavily audited aspect of S-corp returns. "Reasonable" means what an arm's length employer would pay for the same services - based on the officer's experience, duties, comparable salaries in the industry, and the company's revenues and profitability. Paying zero or nominal salary while taking large distributions is the classic audit target.
Self-employed individuals (sole proprietors, partners, and S-corp owner-employees with more than 2% of shares) can deduct 100% of health insurance premiums paid for themselves, their spouse, and dependents as an above-the-line deduction under IRC §162(l). This deduction is taken on Schedule 1 (Form 1040) and reduces AGI - it is not subject to the 7.5% AGI floor that applies to medical expense itemized deductions.
For S-corp owner-employees with more than 2% of shares, the premium must be included in W-2 wages (Box 1) and then deducted on Schedule 1. The deduction is limited to the earned income from the business - it cannot create or increase a loss. If the owner has access to employer-subsidized health insurance through a spouse's employer plan, the deduction is not available for periods when that coverage was available (even if not elected).
| Plan | 2026 Contribution Limit | Deadline | Key Feature |
|---|---|---|---|
| SEP-IRA | 25% of compensation up to $70,000 | Tax return due date including extensions (October 15) | Simple to establish; employer contributions only; no catch-up for over 50 |
| Solo 401(k) | Employee deferral: $23,500 ($31,000 if 50+); employer: 25% of W-2; total: $70,000 ($77,500 if 50+) | Plan must be established by December 31; contributions by tax return due date | Allows Roth contributions; loan provisions; higher limits for high earners; more admin |
| SIMPLE IRA | $16,500 employee deferral ($20,000 if 50+); employer match 2-3% | Salary deferrals must be elected before January 1 of the year; first year by October 1 | Can have employees; lower admin than 401(k); cannot be used if another plan in place |
| Defined Benefit Plan | Up to $280,000 of annual benefit (2026) | Plan established before year-end; contributions can be made up to tax due date | Very high contributions for older, high-income practitioners; actuarially determined |