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For most people who have jobs in the U.S., Social Security contributions are automatic. It is not something you need to worry about because your employer takes care of it on your behalf. When you are self-employed, though, this is not the case. You alone are responsible for your taxes and your Social Security contributions. Here’s what that means for you.
People who work for a traditional employer have one significant tax benefit beyond essential record-keeping benefits. That is the fact that the employer and employee share the Social Security tax burden – each paying 6.2 percent on your earnings and each paying 1.45 percent of earnings as taxes into Medicare.
These payroll taxes are taken out of your paycheck before you even have an opportunity to know they are gone. In many ways, that takes some of the sting out of paying these financial obligations paycheck after paycheck. In 2023, Social Security tax is assessed on the first $160,200 of income, while Medicare tax has no limit for income. Also, individuals who make more than $200,000 and married couples who make more than $250,000 will pay an additional 0.9 percent in Medicare taxes.
On the other hand, self-employed people must shoulder this particular burden alone since you serve as both the employer and the employee in this arrangement, which means that you bear the full force of the Social Security and Medicare taxes. The current contribution you make is 12.4 percent and 2.9 percent, respectively.
As with employer tax rates, you will only pay the Social Security tax on the first $160,200 of your earnings, while Medicare tax applies to your entire income for the year. The total tax burden for self-employed people earning $160,200 or less is 15.3 percent.
While there are many legitimate business expenses you can deduct to reduce your overall income and Social Security tax liability, there is a great deal of debate over whether or not it is in your best interest to do so. Since Social Security is about ensuring some degree of financial security upon retirement, some feel paying the maximum possible amount now will serve you better upon retirement. Unfortunately, that means ignoring the expense deductions and paying the higher rate.
However, that is not always the best way to go about it because Social Security bases the benefits on your income during the 35 working years in which you earned your highest income. That means that if you are making less being self-employed than in other parts of your career, you will want to minimize income. On the other hand, if you are earning on the higher side, you will want to report the higher income level and pay more in taxes now in return for more substantial benefits when you retire.
There are various expenses your business has that are allowed as deductions. That means you can subtract those costs from the income you would otherwise receive to reduce your self-employment tax obligations. One thing to remember is that 6.2 percent, or half of your social security taxes, are also deductible from your total income as a business expense. That means you subtract that amount from your taxable income and only pay taxes on the difference.
If you are self-employed and earn $400 or more, you must report your earnings via the Schedule SE (Form 1040). That form will tell you if your earnings are subject to self-employment tax. However, most self-employed independent contractors or sole proprietors will use Schedule C or C-EZ forms.
Social Security taxes can be pretty complicated. Therefore, it is a good idea to work with an accountant to determine your best long-term strategy for these payroll taxes.
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