The Self-Employment Tax Wage Threshold is Rising. Time to Change Your Freelance Business Entity?

non-deductiible employee expenses

The Self-Employment Tax Wage Threshold is Rising. Time to Change Your Freelance Business Entity?

The Social Security Administration (SSA) recently announced an increase to the maximum amount of wages subject to the old age, survivors, and disability insurance (OASDI) tax. The wage threshold for these taxes will increase to $142,800 in 2021 up from $137,700 in 2020. The OASDI tax rate is 6.2%, Self-employed freelancers will pay these taxes at a 12.4% rate up to the wage threshold limit, to a maximum of $17,707.20 in OASDI tax.

The SSA also announced that recipients of Social Security benefits will receive a 1.3% cost-of-living adjustment and that the earnings test for the amount of income that benefit recipients can receive without having their benefits reduced each year is $18,960 before full retirement age, and the limit taxpayers can earn in the year they reach full retirement age is $50,520, both have increased from 2020.

It is important to note that the Medicare hospital insurance tax of 2.9% for the self-employed, has no wage limit.

The self-employment tax obligations for freelance business owners can really add to your tax bill. For many freelancers, the amount paid in self-employment tax (currently assessed at a rate of 15.3%) is almost as much as that paid in federal income tax, depending on their current tax bracket. For example:

  • Freelancers with taxable income of 0 to $9875 are in the 10% tax bracket.
  • Those with taxable income from $9876 to $40,125 are in the 12% tax bracket.
  • Those with freelance income from $40,126 to $85,525 are in the 22% bracket.

The self-employment tax burden is somewhat mitigated by the ability to claim it as a reduction in income through the employer portion of the social security tax and the Qualified Business Income deduction. However, freelancers may want to look into forming an s-corporation or c-corporation to potentially lower the impact of these taxes.

Consulting with a tax professional before changing your freelance business entity is highly advised to ensure that you consider all of the ramifications of this decision. For example, there are state and local tax considerations which may come into play. For example, the New York City General Corporation Tax, which applies taxes to flow-through profits on s-corps at a rate of 8.8875% may eliminate a significant portion of the  benefit that many freelance business owners anticipate when changing their business entity from a limited liability company or a sole proprietorship to a corporation.