EA Part 1 Self-Employment Tax: Schedule SE, Deductions, and QBI

Self-employed taxpayers face a different tax picture than wage earners: they pay both the employee and employer sides of payroll taxes, but they also get a set of above-the-line deductions that partially offset the cost. EA Part 1 tests the entire SE tax chain — from the initial calculation through the deductions and into the qualified business income deduction.

What Triggers SE Tax

Self-employment tax applies to net earnings from self-employment. This includes:

• Net profit from Schedule C (sole proprietorship)
• Net profit from Schedule F (farming)
• A partner's distributive share of partnership income if the partner is a general partner or is actively participating in a limited partnership's trade or business
• Director's fees
• Certain rental income when services are provided to tenants

SE tax does not apply to wages subject to FICA, dividends, capital gains, passive rental income (without services), or S corporation distributions.

The SE Tax Calculation: 15.3% on 92.35%

SE tax is composed of:

• 12.4% Social Security tax on net earnings up to the Social Security wage base ($168,600 for 2024)
• 2.9% Medicare tax on all net earnings (no wage base cap)

The tax is not calculated on 100% of net SE income. Instead, it is calculated on 92.35% of net SE income. This reduction mimics the fact that employees pay 7.65% on their gross wages while employers pay an additional 7.65% on top — the 92.35% factor essentially puts the self-employed person on equal footing with the employee.

Example: A taxpayer has $100,000 of net Schedule C profit.

1. $100,000 × 92.35% = $92,350 of self-employment earnings
2. SE tax = $92,350 × 15.3% = $14,129.55

For high earners, an additional 0.9% Additional Medicare Tax applies to SE earnings above $200,000 (single) or $250,000 (MFJ). This additional tax is not deductible.

Deduction for Half of SE Tax

Because self-employed taxpayers pay both sides of payroll taxes, the IRS allows them to deduct one-half of SE tax as an above-the-line adjustment to income on Form 1040, Schedule 1.

This deduction mirrors the fact that employers can deduct their share of FICA taxes as a business expense. It does not reduce SE tax itself — it only reduces income tax.

Using the example above: $14,129.55 ÷ 2 = $7,064.78 deduction.

Self-Employed Health Insurance Deduction

Self-employed taxpayers who are not eligible to participate in an employer-subsidized health plan (their own or a spouse's) may deduct 100% of health insurance premiums paid for themselves, their spouses, their dependents, and any child under age 27 as an above-the-line deduction.

Limits:

• The deduction cannot exceed net profit from the business
• If the taxpayer was eligible for employer coverage for even one month, no deduction is allowed for that month's premiums
• Long-term care insurance premiums also qualify up to the age-based limits

This deduction does not reduce net SE earnings for SE tax purposes — it only reduces income tax.

SEP-IRA Contributions

A self-employed taxpayer can contribute to a Simplified Employee Pension (SEP-IRA) and deduct the contribution above the line. The contribution limit is the lesser of:

• 25% of net self-employment compensation (net earnings reduced by the SE tax deduction and then by the contribution itself — this circular calculation results in an effective rate of approximately 18.59% of net SE profit)
• $69,000 for 2024

SEP-IRA contributions must be made by the due date of the return, including extensions.

The Qualified Business Income (QBI) Deduction

Under IRC §199A, eligible self-employed individuals and pass-through business owners may deduct up to 20% of qualified business income from their taxable income (not AGI). This deduction is in addition to the SE tax deduction and health insurance deduction.

Basic calculation: 20% × QBI, where QBI is generally the net profit from the qualified trade or business reduced by the deductible portion of SE tax and SE health insurance premiums.

Limitations for high-income taxpayers: For 2024, the deduction begins to phase out when taxable income exceeds $383,900 (MFJ) or $191,950 (single). Above the fully phased-out threshold, the deduction is limited to the greater of:

• 50% of W-2 wages paid by the business, or
• 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified depreciable property

Specified Service Trades or Businesses (SSTBs): Businesses in health, law, consulting, financial services, and certain other fields are SSTBs. The QBI deduction for SSTBs phases out completely for high-income taxpayers — there is no wage/property limitation workaround.

Overall limit: The total QBI deduction cannot exceed 20% of (taxable income minus net capital gain).

For EA Part 1 purposes, focus on the basic 20% deduction concept and the SSTB phase-out rule. The wage and property limitations are tested more heavily on EA Part 2.

Estimated Tax Payments

Self-employed taxpayers generally do not have wages from which withholding is taken. They must pay estimated taxes quarterly using Form 1040-ES to avoid an underpayment penalty.

The safe harbor amounts:

• 90% of the current year's tax liability, or
• 100% of the prior year's tax liability (110% if prior year AGI exceeded $150,000)

Estimated tax payments are due April 15, June 15, September 15, and January 15 of the following year.

Common Exam Traps

Trap 1: The 92.35% factor is applied to net Schedule C profit (after deducting business expenses), not gross revenue.

Trap 2: The SE health insurance deduction reduces income tax but does not reduce SE tax. Students frequently confuse it with the deduction for half of SE tax.

Trap 3: Partners in a limited partnership are generally not subject to SE tax on their distributive share of partnership income. However, guaranteed payments to limited partners are subject to SE tax.

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