If you're self-employed, you obtain Social Security and Medicare coverage through the payment of self-employment tax. These are figured on Schedule SE.
If your net earnings from self-employment equals $400 ($400) or more, you must:

• File Schedule SE
• Pay self-employment tax

This is true regardless of your age, and even if you're receiving Social Security benefits.
The self-employment tax rate is normally 15.3%. However, for 2011 and 2012, there was a 2 percentage point reduction in the Social Security tax rate due to the payroll tax holiday. So, for 2011 and 2012, the 13.30% self-employment tax rate is comprised of both the:

• 10.4% Social Security tax
• 2.90% Medicare tax

For 2012, the maximum amount subject to Social Security tax is $110,100 . However, all self-employment income in excess of $400 is subject to Medicare tax.

To calculate net earnings from self-employment, multiply your net business profit by 92.35%. Why this percentage? An employee is only required to pay 1 / 2 of Social Security and Medicare taxes, or 5.65% of wage income. However, for 2011 and 2012, the employee portion is further reduced by 2 percentage points. That's because of the payroll tax holiday that reduced the Social Security tax by 2% in 2011 and 2012. A self-employed individual must, in effect, pay "both halves," or 13.30%. So, the law equalizes the tax burden by reducing the income subject to tax by 7.65% (100% - 5.65% = 92.35%).

You can deduct the employer portion of your self-employment tax as an adjustment to income on Form 1040. The amount you can deduct is usually 1 / 2 of the employer portion. This decreases your taxable income and, as a result, your federal income tax. (Ex: Half of your self-employment tax is $1,000 and you're in the 25% tax bracket. This saves you $250 in federal income taxes.)

Example: Your only income in 2012 is $32,000 in net self-employment income, and you have no adjustments other than the deduction for 1 / 2 of your self-employment tax.

Your self-employment tax is $3,930:

$32,000 (self-employment income) x 92.35% (amount of income taxed) x 13.3% (tax rate) = $3,930

Your total adjustment to income is $2,260, which is $3,930 x 57.51%. For 2011 and 2012, you multiply your total self-employment taxes by 57.51% instead of 50% because of the 2 percentage point reduction in the employee portion of the Social Security tax. Because the 2 percentage point reduction only applies to the employee portion, an adjustment has to be made so that the deductible employer portion is reflected at 7.65% instead of the 5.65% that is the employee portion.

And your adjusted gross income is $29,740:

$32,000 (self-employment income) - $2,260 (self-employment tax deduction) = $29,740