Understanding Self-Employment Tax
Income tax, self-employment tax, social security tax, net investment income tax and the list goes on; it is often difficult to understand the various taxes imposed by the Federal, State, and Local governments. It would take a novel to describe them all, but we will dig deeper into one, often confusing tax, known as self-employment tax.
Self-employment tax consists of Social Security and Medicare taxes for self-employed individuals. The terms are often used interchangeably when consulting with tax advisors. It appears to imply a different type of Federal income tax, but upon closer investigation, it is simply the Social Security and Medicare taxes. It is reported and paid alongside the Federal income tax, and the allocation of Social Security and Medicare taxes for a self-employed taxpayer are calculated on schedule SE, found in the 1040 individual income tax return. Social Security and Medicare taxes fall under the Federal Insurance Contributions Act (FICA) which is why it also referred to as FICA tax when combining the Social Security and Medicare taxes.
Another complicated and often misunderstood component of self-employment tax pertains to the fact self-employed individuals must bear the full burden of the tax whereas employees (non self-employed individuals) only bear-half of the burden of the FICA liability. Their employer is responsible for paying the other half of the liability.
The breakdown is as follows:
Total to be remitted equals 15.3%
Self-employed persons pay 12.4% Social Security and 2.9% Medicare which equals 15.3% (calculated on net income from self-employment)
Employees pay half of the above amounts 6.2% Social Security and 1.45% Medicare (calculated on gross pay) and their Employers pay a match of those same amounts to fulfill the 15.3% total required
Self-employed individuals do not have the luxury of remitting their Social Security and Medicare taxes each month because they generally don't receive a payroll check like employees. Due to this fact, it is important for self-employed taxpayers to understand they are responsible for paying the full 15.3% and to properly plan for the payment of tax when revenue is generated so not to be surprised at tax deadline time.
Article by: Jeremy Fortner, Tax Manager