When most people think about taxes, they think about income tax. The number on their W-2, the bracket they fall into, and the refund they might get in April.
What almost nobody talks about, at least not until they're self-employed and staring at a tax bill they didn't expect, is the second tax system running alongside the first. It operates differently, follows a different logic, and for lower-earning freelancers, can actually hit harder than income tax.
Understanding both is essential for tax planning. Let's break them down: what they are, how they work, and what the numbers look like side by side.
Tax system one: Federal income tax (the progressive system)
Federal income tax is the system most people know. It’s progressive, meaning the more you earn, the higher the percentage you pay, but only on income above each threshold. Think of it like climbing a staircase. Each step up is a new bracket, and you only pay the higher rate on the dollars that land on that step. The dollars on the lower steps stay taxed at the lower rates.
This is why your top tax bracket and your effective tax rate (the actual percentage of your total income that goes to federal income tax) are almost never the same. You might be in a higher bracket, but that doesn't mean all your income is taxed at that rate.
For self-employed individuals, federal income tax is calculated on your net income, which is your gross revenue minus allowable business expenses. As your net income grows, your income tax liability grows with it.
If you've been trying to understand how the marginal tax system applies to your self-employment income, Self-Employed 101 walks through exactly how it works with real numbers, so you can make smarter business decisions.
Tax system two: Self-employment tax (the regressive system)
This is the one that catches people off guard.
Self-employment tax is a separate tax that funds Social Security and Medicare. You've likely seen this come out of a paycheck as FICA (Federal Insurance Contributions Act). When you worked for an employer, they paid half of this for you. Now that you're self-employed, you cover both halves. That's why your tax obligation can feel much higher as a freelancer than it did as an employee.
What makes self-employment tax different from income tax is that it’s regressive, not progressive. Instead of increasing as your income rises, it applies at a flat rate. Everyone pays the same percentage, whether they earn $50,000 or $500,000. On the surface, that might sound fair. In practice, the effect is anything but equal.
Meet Sarah and Linda
Let's look at how self-employment taxes affect two freelancers, Sarah and Linda, using illustrative rates for this example.
(Note: Actual rates change, so always verify current figures with the IRS.)
For our purposes, we're using simplified rates to make the math easy to follow. Social Security is taxed at 12% on earned income up to $120,000, and Medicare is taxed at 3% on all earned income. The actual combined rate is 15.3%, but a rounded 15% shows the same principle.
Sarah makes $100,000. Her income is below the $120,000 Social Security cap, so she pays 12% on her full $100,000 ($12,000). She also pays 3% Medicare on her full $100,000 ($3,000). Her total self-employment tax is $15,000, which is 15% of her total earnings.
Linda makes $500,000. Her income exceeds the $120,000 Social Security cap, so she only pays 12% on the first $120,000 ($14,400). The remaining $380,000 of her income is not subject to Social Security tax. She pays 3% of her full $500,000 in Medicare ($15,000). Her total self-employment tax is $29,400, which is just 5.9% of her total earnings.
Linda earns five times as much as Sarah, yet Sarah's effective self-employment tax rate is nearly three times higher than Linda's. Sarah pays 15 cents of every dollar she earns toward Social Security and Medicare. Linda pays less than 6 cents.
This is what a regressive tax system looks like. Because Social Security has a cap, higher earners hit that ceiling and stop paying into it, while Medicare continues to apply. The result is that a larger share of a lower-income earner's total income goes toward self-employment taxes than it does for someone earning several times as much.
Why this matters for your tax planning
Understanding both systems directly affects how you should handle your taxes throughout the year.
For lower-earning freelancers, the self-employment tax can be a huge portion of their total tax obligation. Someone who focuses only on income tax and forgets to account for the flat-rate SE tax is almost certainly underestimating what they'll owe. That's the exact scenario that leads to underpayment penalties and surprise tax bills.
It's also worth noting that paying into Social Security and Medicare does more than satisfy a tax obligation; it registers your earnings with the Social Security Administration. If you haven't paid in for enough quarters over your working life, you may not be entitled to full Social Security benefits when you're eligible. In that sense, your self-employment tax is also a contribution toward your own future.
Knowing how both tax systems apply to your income is a key part of tax planning. Self-Employed 101 walks through both systems in full so you can calculate your total liability accurately and plan with confidence.
The part nobody mentions
One of the most frustrating things about becoming self-employed is that nobody hands you a guide. You figure out your services, you start bringing in income, and then somewhere down the line, the reality of freelancer taxes becomes very clear, very fast.
The progressive income tax system has an intuitive logic: more income, more tax. The regressive self-employment tax system doesn't work that way. It's flat, it has a cap that benefits higher earners, and it's calculated on top of income tax, not instead of it. Most people don't learn this until they're already navigating both systems without a map.
The structure of these two systems is learnable. Once you understand both of them, how they interact, and how to build that into your financial planning, you're operating with a huge advantage over the version of yourself that was just guessing.
The goal isn't to be overwhelmed by the complexity. It's to get clear on the fundamentals so that every income decision you make is informed by what you actually owe, not what you vaguely assume you might owe.
Ready to understand exactly how these two tax systems apply to your income and how to build a tax planning strategy that works year-round? Self-Employed 101 was built for freelancers who want to stop being surprised and start being prepared.
