Self Employment Tax

What it is

Self-employment tax is an extra 15% tax that the government puts on you when you’re self-employed. When you’re an employee, your employer pays half of Social Security and Medicare. When you’re self-employed, you pay both halves. That’s it. It’s not complicated, it’s just ugly.

A flipper ends up having to pay 50 to 60% of their profits. You make 60,000 bucks on a flip, you might be paying half of that or better to the IRS for your winnings.

That’s not hyperbole. House flips are ordinary income — the IRS treats you as a dealer, not an investor — so you don’t get capital gains rates. Then SE tax stacks on top of that. It’s a real number and it catches people off guard.

Why it matters

The reason the holdco/opco structure matters is mostly about this. Ordinary income and SE tax together take a bite that changes whether the math on a flip actually works. The defense is legal structure — but specifically an S-Corp election for the opco.

Another strategy you can use to mitigate self-employment tax is setting up your business as an S-corp. Instead, you get to mitigate that 15% self-employment tax.

The S-Corp doesn’t eliminate it — you still pay yourself a reasonable salary, which gets hit with SE tax — but you can pull remaining profits as a distribution that avoids SE tax. If your opco is pulling $100K in profit, the difference between running that as a sole proprietor versus an S-Corp on SE tax alone can be $10-15K.

On the $91K total deal from the intentionally-lose-money example: $50K came out of the opco. After the IRA, solo 401k, and business expenses, taxes on that $50K came down to around $10K. Without any structure, you’d have paid something close to $45K on the $90K total. The strategies — including managing SE tax exposure — got it down to around $30K. “You see how taxes are a huge part of the game. It’s not just offense, it’s about the defense.”

How it shows up

Every flipper running as a sole prop or a single-member LLC taxed as a sole prop is getting hit with SE tax on every dollar of profit. It’s the first thing to fix once your volume justifies the administrative cost of the S-Corp.

The other side of it: rental income is not subject to SE tax. That’s one of the reasons Ross says rental real estate is better than flipping on a tax basis. Rentals generate passive income. Flips generate self-employment income. “The tax laws are set up for long-term real estate investors because that’s who wrote the tax code. But flippers, well, we kind of get screwed.”

That asymmetry is the whole argument for using flips to fund rentals and eventually shifting the income mix. The goal isn’t to flip forever — it’s to build a rental base that produces income the government treats better.

Related

holdco opco, defined benefit, Solo 401K, depreciation, taxes, wealth engines, ordinary income