Self-Employment Tax
Definition
Self-employment tax is a 15.3% federal tax consisting of two parts: 12.4% for Social Security and 2.9% for Medicare. It is the equivalent of the FICA taxes that are automatically withheld from a W-2 employee's paycheck. When you are self-employed (such as owning a default LLC), you are both the employer and the employee, so you must pay both halves of this tax.
Why it matters
Many new business owners get a shock at tax time because they forget about self-employment tax. This tax is paid in addition to your normal federal and state income taxes. If your default LLC makes $100,000 in profit, you owe $15,300 in self-employment tax right off the bat, before regular income tax is even calculated. (Note: Only 92.35% of your net earnings are actually subject to the tax, but the math is still painful). This is why highly profitable LLCs often elect S-Corp status to legally reduce this burden.
Example
Sarah is a freelance web developer with a single-member LLC. She nets $80,000 in profit this year. Because she is taxed as a disregarded entity, she owes the 15.3% self-employment tax on that profit (roughly $11,300). This money goes to fund her personal Social Security and Medicare accounts.