For most people who have jobs in the U.S., Social Security contributions are something that is 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.
Social Security for the Employed
People who work for a traditional employer have one significant tax benefit that goes beyond basic record keeping benefits. That is the fact that the employer and employee share the Social Security tax contribution – each one paying 6.2 percent on your earnings as well as 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.
Social Security Responsibilities for the Self-Employed
Those who are self-employed, on the other hand, must pay the full percentage on their own since you serve as both the employer and the employee in this arrangement. What this means is that you bear the full force of the Social Security and Medicare taxes. The current contribution you are expected to 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 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, there are many who feel paying in the maximum possible amount now, will serve you better upon retirement. 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 benefits are based on your income during the 35 working years in which you earned your highest income. That means that if you are earning 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 larger benefits when you retire.
Business Expenses Impact on Amount Due
There are various expenses your business has that are allowed as deductions. That means you can subtract those expenses 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 the self-employment tax. Most people who are self-employed as independent contractors or sole proprietors will use Schedule C or C-EZ forms.
Social Security taxes can be quite complex. It is a good idea to work with an accountant to determine your best long-term strategy for these payroll taxes.