Understanding the difference between the self-employment tax and income tax is essential for small business owners as they navigate their financial responsibilities. The self-employment tax is applicable to individuals who work for themselves; it includes Social Security and Medicare contributions. Alternatively, income tax is a progressive tax levied against all individuals based on earnings, including wages, salaries and self-employment income. Both taxes significantly affect the net income, cash flow and long-term financial planning for small businesses.
What you’ll learn
What you’ll learn
Updated: May 31, 2025
Key takeaways
- The self-employment tax (15.3%) funds help fund Social Security and Medicare benefits
- Income tax funds the government and supports public services.
- Self-employed people pay both the self-employment tax and income tax
As the landscape of small businesses evolves, understanding the differences in tax types is becoming increasingly consequential. The rise of the gig economy and the prevalence of freelance and contract work necessitates an awareness of tax obligations and the ability to weigh the benefits of self-employment against the tax liabilities and other costs it entails.
The process calls for a clear understanding of payroll vs. income tax, and this guide is designed to help. It breaks down the nuances of the self-employment tax and income tax.
Before delving into the details, let’s frame things with some big picture insights from Tom Brock, a licensed CPA and CFA charterholder and frequent OnPay contributor. Tom has extensive experience advising small businesses, which makes him particularly well-positioned to address a question that comes up quite a bit for both new and seasoned business owners.
Is the self-employment tax and income tax the same?
“The self-employment tax and income tax are both federal taxes levied against individuals earning income, but they are different. Income tax pertains to all taxpayers and is based on taxable income, which includes wages, salaries, commissions, self-employment earnings, interest and dividends. It funds the federal government’s operations and is calculated using a progressive rate structure that varies based on filing status and income level.
The self-employment tax, on the other hand, pertains to individuals who work for themselves (i.e., gig workers, freelancers and small business owners). It exists to support the Social Security and Medicare programs, which all taxpayers must pay into. However, unlike traditional employees, self-employed individuals must pay both the employer and employee portions of these taxes — amounting to 15.3% of subject earnings.”
— Tom Brock, CFA, CPA
Understanding self-employment tax
Fundamentally, the self-employment tax is a tax imposed on earnings from self-employment to help fund two of the United States’ key social welfare programs – Social Security and Medicare. Small business owners need to understand this tax, because it can have a significant impact on net income and cash flow.
Purpose of the self-employment tax
The purpose of the self-employment tax is to secure funding for Social Security and Medicare benefits. In a traditional employee-employer relationship, each party pays an equal share of the FICA tax rate, which totals 12.4% for Social Security and 2.9% for Medicare. Conversely, self-employed individuals must pay both the employer share and employee share of these programs via the self-employment tax. Fortunately, as discussed in a few minutes, allowances and deductions exist that can reduce a self-employed person’s FICA-related tax burden to a level that compares to that of traditional employees.
Self-employment taxpayers
The self-employment tax affects people who earn income through self-initiated business activities and ventures. Typically, this includes freelancers, independent contractors and small business owners. Self-employment taxes, or independent contractor taxes, are paid by anyone who independently collects positive net earnings of $400 or more on an annual basis.
Calculating the self-employment tax
Calculating the self-employment tax begins with determining your net earnings. Net earnings result from subtracting business expenses from gross income. For example, a self-employed person that generates gross income of $80,000 and incurs business expenses totaling $15,000 has net earnings of $65,000.
Next, you take net earnings and adjust the figure downward to determine taxable income. You see, a self-employed individual only pays taxes on 92.35% of his or her net earnings. Continuing with our example, taxable income is $60,027.50 ($65,000 x 92.35% = $60,027.50).
Then, to calculate the self-employment tax, multiply taxable income by the 15.3% rate. Continuing with our example, the self-employment tax is $9,184.21 ($60,027.50 x 15.3% = $9,184.21).
Good to know
For 2025, the maximum amount of earnings subject to the Social Security component of the self-employment tax is $176,100. There is no cap on the Medicare component.
Deduction for half of the self-employment tax
It’s very important to note that a deduction exists, whereby a self-employed person is allowed to deduct one-half of the self-employment tax incurred on his or her income tax return. Continuing our example above, this equates to a $4,592.11 income tax deduction ($9,184.21 x 50% = $4,592.11).
Do you pay more taxes if you are self-employed?
“On the surface, self-employed individuals appear to pay more in taxes than traditional employees, because they are responsible for both the employer and employee portions of the Social Security and Medicare taxes. However, application of the 50% self-employment tax deduction reduces a self-employed person’s FICA-related tax burden to a level that compares to that of a traditional employee.
Additionally, a self-employed person may be able to reduce his or her tax liability via an array of other business deductions, such as home office expenses, business equipment expenditures, property/casualty insurance premiums and health insurance premiums.”
— Tom Brock, CFA, CPA
Now that we have a foundational understanding of the self-employment tax, let’s take a closer look at income tax, including how it works, why it exists and how it is calculated.
Understanding income tax
Income tax is a progressive tax imposed on virtually all individual earnings, including those generated from both traditional employment and self-employment.
Purpose of income tax
Income tax is a significant source of revenue for government operations and public services. It funds critical social welfare programs, such as education, healthcare, defense and infrastructure. The goal of the income tax is to allocate the financial burden of these programs equitably via progressive taxation, whereby relatively high-income earners are subject to a higher effective tax rate than relatively low-income individuals. That said, the efficacy of the system is a source of constant debate and legislative change.
Did you know?
Within a progressive tax system, the effective tax rate is the average rate at which a taxpayer is taxed. It is calculated by dividing total income tax incurred by taxable income.
Income taxpayers
Income tax applies to a vast pool of earners, which includes wage earners, business owners, self-employed people and investors. The broad applicability ensures that nearly all people contribute to government operations, and various rules, income thresholds and tax rate brackets exist to help ensure the equitable assignment of the income tax.
Calculating income tax
Calculating income tax begins with determining taxable income, which results from subtracting allowable exemptions and deductions from gross income. Then, you must multiply taxable income by the tax rates corresponding to the various income tiers specified in the IRS’ tax brackets.
How income tax is collected
Virtually everyone must pay income tax, but the payment method for traditional employees differs from that of self-employed individuals. An employer typically withholds income taxes from an employee’s paychecks and remits the money to the government. However, at the end of the year, the employee must self-report his or her tax obligation and directly settle any reconciling differences with the government.
Conversely, self-employed individuals must remit quarterly payments to the government to ensure compliance with IRS regulations. We address this process in more detail below. For now, let’s take a look at a handful of remaining topics relating to income tax.
Available deductions for income tax
Taxpayers have numerous deductions that can help reduce their income tax liabilities. Common deductions include those for mortgage interest, charitable contributions and medical expenses.
Individual taxpayers are not the only beneficiaries of income tax deductions. Small business owners can also significantly benefit from understanding and claiming eligible deductions. There are a wide array of deductions available for ordinary and necessary business expenses, such as tools and supplies.
State and local vs. federal income tax impact
Thus far, we have addressed income tax from the perspective of the federal government. However, it’s important to note that many states and local municipalities impose their own income taxes. The interplay of local, state and federal income taxes can create challenges and confusion for taxpayers. Financial planning software and payroll management tools can help small business owners keep accurate tax records and reduce the risk of compliance issues.
Mixed income sources
Taxpayers with mixed income sources face unique challenges. Different regulations apply to earned income versus investment income. Careful categorization and knowledge of the tax treatment of each income type are essential to ensure compliance and avoid penalties.
Do LLCs pay self-employment tax?
Owners of single-member LLCs and members of multi-member LLCs generally pay the self-employment tax on their share of the business’s income, because, by default, the IRS considers these entities to be sole proprietorships or partnerships. However, an LLC that elects to be taxed as an S corporation can potentially reduce the self-employment tax by paying owners a reasonable salary and treating remaining profits as distributions. In this situation, only the owners’ salaries are subject to the self-employment tax.
— Tom Brock, CFA, CPA
Self-employment tax vs. income tax
Understanding the distinctions between the self-employment tax and income tax allows small business owners to manage their obligations strategically. A breakdown of the key differences is as follows:
| Feature | Self-employment tax | Income tax |
| Purpose | Funds Social Security and Medicare | Funds government and social programs |
| Tax rate | Typically 15.3% (but the Social Security component is capped) | Variable rate based on progressive tax brackets |
| Calculation basis | Calculated based on 92.35% of taxable net earnings | Calculated on total taxable income less deductions and exemptions |
Things all taxpayers must know
Whether you are self-employed or working for someone else, there are a few tax requirements that could affect you. Read on to expand your awareness and avoid problems with the IRS.
Estimated payments
If the amount of income tax withheld from your salary is inadequate or if you receive interest, dividends, capital gains, alimony or self-employment income, you may have to make estimated tax payments to the IRS on a quarterly basis. Failing to make these payments can result in penalties and interest charges. The IRS provides Form 1040-ES, Estimated Tax for Individuals to help individuals figure and pay their estimated taxes.
Medicare tax for higher earnings
Individuals earning over a specific threshold ($200,000 for individuals and $250,000 for married couples) must pay an additional 0.9% on the standard 2.9% Medicare tax, bringing the total rate to 3.8%.
Manage your taxes effectively
Understanding the differences between the self-employment tax and income tax helps small business owners navigate the complex landscape of tax compliance, but managing the details can be an administrative hassle. As a result, many people count on payroll software for small businesses to help calculate taxes, file correct forms and automate year-end reporting. If you have questions about how different platforms shape up and how OnPay enters into the equation, we’d love to hear from you!
Take a tour to see how easy payroll can be.
Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.