IRC 1402: Net Earnings from Self-Employment and SE Tax

Net earnings from self-employment, or NESE, is the figure the IRS uses to calculate your self-employment tax. It equals 92.35% of your net business profit, adjusted for certain partnership items and statutory exclusions defined in IRC Section 1402. You owe self-employment tax once NESE reaches $400 in a tax year, and the combined rate is 15.3% up to the Social Security wage base ($184,500 for 2026), with the 2.9% Medicare portion applying to every dollar above that.¹

How to Calculate Your Net Earnings from Self-Employment

Start with gross income from your trade or business. Subtract your allowable business deductions. That gives you net profit, which is not the same as NESE. The tax code applies a 92.35% multiplier to net profit before self-employment tax is calculated.² The multiplier exists because employees pay FICA on wages that already have the employer’s share stripped out; the adjustment puts self-employed earners on comparable footing.

The calculation happens on Schedule SE, which pulls income from Schedule C for sole proprietors or Schedule K-1 for partners.³ If your total across all self-employment activities is under $400, you owe no SE tax and don’t need to file Schedule SE at all.⁴

A trade or business, for this purpose, requires regularity, continuity, and a profit motive. That threshold determines whether your activity produces self-employment income in the first place.

Income That Does Not Count Toward NESE

IRC 1402 carves out categories of income that never enter the NESE calculation, even when they flow through a business. The logic behind the exclusions is that self-employment tax targets earned income from personal effort, not passive returns on capital.⁵

Rental Income from Real Estate

Rent from real estate is excluded from NESE, along with rent from personal property leased with the real estate. Most residential and commercial landlords are covered by this general rule. Two exceptions pull rental income back in:

If your trade or business is buying and selling real estate, rent earned along the way is included in NESE.
If you provide substantial services to tenants beyond basic maintenance, the income starts to look like compensation rather than a return on capital. Running a hotel or bed-and-breakfast crosses that line. Mowing the lawn or handling occasional repairs does not.

For agricultural land, there is a separate rule. If you own farmland and someone else produces crops or livestock on it, the income is included in NESE only if you materially participate in the production or its management.

Interest, Dividends, and Capital Gains

Stock dividends and bond interest are excluded from NESE unless you are a dealer in stocks or securities, meaning your actual business is trading financial instruments. Holding investments on the side, even a large account, does not make you a dealer.⁵

Gains or losses from selling capital assets are also excluded. That covers selling business equipment, investment property, or other assets not held for sale to customers in the ordinary course. Selling your delivery van at a profit produces a capital gain, not NESE. But if your business is flipping vehicles for resale, those sales are ordinary business income and the profit is included.

Conservation Reserve Program Payments

Annual CRP rental payments from the USDA are generally included in NESE. The exception: if you are already receiving Social Security retirement or disability benefits, CRP payments are excluded.⁶ Retired farmers often assume CRP income is passive rental income by default. It is not.

Retired Partner Payments

Periodic payments to a retired partner are excluded from NESE when they are made under a written retirement or disability plan, continue for the partner’s life, and the partner has stopped performing services for the partnership. A similar exclusion applies to termination payments received by former insurance salespeople.

Hobby Income and Statutory Employees

Two situations look like self-employment but produce no SE tax. If the IRS treats your activity as a hobby rather than a business, the income is still taxable, reported on Schedule 1, but it is not subject to self-employment tax. You also cannot deduct hobby losses against other income.⁷ The IRS weighs several factors: whether you keep accurate books, how much time and effort you invest, whether you depend on the income, whether you’ve adjusted methods to improve profitability, and whether the activity has been profitable in some years. No single factor decides it.

Statutory employees file business income on Schedule C but owe no SE tax. They receive a W-2 with the “Statutory employee” box checked, meaning the employer has already withheld FICA. The four categories cover certain delivery drivers, full-time life insurance sales agents, home-based workers using employer-supplied materials, and full-time traveling salespersons. If that W-2 box is checked, do not layer SE tax on top.

Partnership and LLC Income

Flow-through entities create the most contested territory in NESE. Your classification depends on whether you are a general partner, a limited partner, or an LLC member, and the answer is not always what the organizing documents suggest.

General Partners

A general partner’s distributive share of ordinary income from the partnership’s trade or business is included in NESE, whether or not the cash is actually distributed. Active participation makes the share earned income.⁵

Limited Partners

IRC 1402(a)(13) excludes a limited partner’s distributive share of partnership income from NESE. The only piece that remains subject to SE tax is guaranteed payments for services actually rendered.⁸ The exclusion was written for passive investors who put in capital without running the business.

Courts have narrowed the exclusion for people who use limited partner status as a label. In Renkemeyer, Campbell & Weaver, the Tax Court held that partners in a law firm organized as an LLP could not claim the 1402(a)(13) exclusion, because their income came from personal legal services rather than a return on invested capital. Calling yourself a limited partner in a service business will not shield your income from SE tax if the substance of what you do is provide services.

LLC Members

Multi-member LLCs taxed as partnerships are the most unsettled corner of SE tax law. LLC members can participate fully in management without losing limited liability protection, unlike traditional limited partners, so the limited-partner label does not map cleanly onto them. The IRS generally treats active LLC members as general partners for SE tax purposes. If you are actively involved in operations, plan on paying SE tax on your share.

Guaranteed Payments Versus Distributive Shares

Guaranteed payments are amounts paid to a partner for services (or for the use of capital) regardless of whether the partnership turns a profit. They function like a salary and are always included in NESE, for both general and limited partners.⁸ A distributive share is your allocated portion of partnership net income or loss. For a general partner, the distributive share is subject to SE tax; for a qualifying limited partner, it is excluded. The IRS scrutinizes arrangements where partners take disproportionately large distributive shares and small guaranteed payments, because the classification of a payment changes the tax outcome.

S Corporations Sit Outside the NESE Framework

S corporation distributions to shareholders are not subject to self-employment tax. Income flows through on Schedule K-1, but unlike partnership income, it does not trigger SE tax.⁹ The catch: any shareholder who performs more than minor services must receive reasonable compensation as a W-2 employee, with normal FICA withholding. Shareholders who take distributions instead of wages have been found liable for employment taxes on what should have been compensation. High distributions paired with a suspiciously low salary is a common audit trigger.

Ministers and Religious Workers

Ordained ministers, members of religious orders who have not taken a vow of poverty, and Christian Science practitioners are subject to a distinct set of rules. Their service income is treated as self-employment income by default, even if their church issues a W-2.¹⁰ While actively serving, a minister includes in NESE the fair rental value of a parsonage or any housing allowance received, even though that amount may be excluded from income tax under IRC 107. After retirement, the parsonage allowance and any church retirement benefits are excluded from NESE. A minister conscientiously opposed to public insurance can file Form 4361 to opt out irrevocably, which also forfeits Social Security coverage based on ministry earnings.

The Self-Employment Tax Rate and How It Applies

The combined SE tax rate is 15.3%, split between 12.4% for Social Security and 2.9% for Medicare.¹¹ The pieces behave differently once your income gets high enough.

The Social Security Cap

The 12.4% Social Security portion applies only to NESE up to the annual wage base. For 2026, that cap is $184,500.¹² Every dollar of NESE above the cap escapes Social Security tax. The 2.9% Medicare portion has no cap.

Additional Medicare Tax

An extra 0.9% Medicare tax applies to self-employment income above these filing-status thresholds:¹³

Single or head of household: $200,000
Married filing jointly: $250,000
Married filing separately: $125,000

Above the thresholds, the total Medicare rate becomes 3.8%. These thresholds are not indexed for inflation and have not changed since the tax began in 2013.

The Deduction for Half of SE Tax

You can deduct one-half of your self-employment tax as an above-the-line adjustment on Form 1040. This reduces adjusted gross income but does not reduce NESE for purposes of the SE tax calculation itself.² The deduction mirrors the treatment employers get for their half of FICA. The 0.9% Additional Medicare Tax is not part of the deductible amount.

When You Have W-2 Wages and Self-Employment Income

If you earn wages from an employer and also have self-employment income, Social Security tax on your wages is applied first. You then owe the 12.4% Social Security portion of SE tax only on self-employment earnings that, combined with your wages, stay under the $184,500 cap.¹⁴

Say you earn $100,000 in W-2 wages and $85,500 in net self-employment earnings in 2026. Your employer already withheld Social Security tax on the full $100,000. You would owe the 12.4% Social Security tax on only $84,500 of self-employment earnings (the amount left to reach the $184,500 cap). The remaining $1,000 owes only the 2.9% Medicare tax.

Paying Estimated Tax Throughout the Year

Self-employed individuals pay taxes in quarterly installments rather than through paycheck withholding. Underpaying or missing a payment triggers an underpayment penalty at a rate the IRS sets each quarter.

Quarterly due dates:¹⁵

Income earned January 1 through March 31: due April 15
Income earned April 1 through May 31: due June 15
Income earned June 1 through August 31: due September 15
Income earned September 1 through December 31: due January 15 of the following year

You avoid the underpayment penalty by paying at least 90% of your current-year tax liability, or 100% of last year’s tax liability, through timely estimated payments and any withholding. If your prior-year AGI was over $150,000 ($75,000 if married filing separately), the safe harbor rises to 110% of the prior-year tax. You also avoid the penalty if you owe less than $1,000 after subtracting withholding from your total tax.

1
Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes)
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Internal Revenue Service. Topic No. 554, Self-Employment Tax
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Internal Revenue Service. Schedule SE (Form 1040) – Self-Employment Tax
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Internal Revenue Service. Schedule C and Schedule SE FAQ
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Office of the Law Revision Counsel. 26 USC 1402 – Definitions
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Internal Revenue Service. Conservation Reserve Program Annual Rental Payments and Self-Employment Tax
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Internal Revenue Service. Here’s How to Tell the Difference Between a Hobby and a Business for Tax Purposes
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Internal Revenue Service. Are Partners in a Partnership Considered Employees or Self-Employed?
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Internal Revenue Service. S Corporation Employees, Shareholders and Corporate Officers
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Social Security Administration. Social Security Handbook – Exemptions from Self-Employment Coverage
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Office of the Law Revision Counsel. 26 USC 1401 – Rate of Tax
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Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security
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Internal Revenue Service. Topic No. 560, Additional Medicare Tax
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Social Security Administration. If You Are Self-Employed
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Internal Revenue Service. Estimated Tax