What is Self-Employment Tax?
If you are employed by a company, your employer is required to withhold Medicare and social security taxes from your paycheck. Nothing new there, right?
However, what you may not know is that your employer is also required to match the Medicare and social security taxes being withheld from your paychecks. In other words, the Medicare and social security taxes paid by your employer are double what is being withheld from your check.
Of course, if you are your own employer (self-employed), then guess who gets to pay the Medicare and social security match amount? That's right, YOU DO!
So self-employment tax is basically the matching amount you pay as your own employer, plus the tax amount you pay as your own employee.
Furthermore, even if you earn wages from an employer, but you earn more than $400 annually from a side business of your own, you will still need to pay self-employment taxes on the profits your side business generates.
What is the Self-Employment Tax Rate?
The following chart shows the Medicare and social security tax rates for 2018:
|Social security rate:||6.2%||6.2%||12.4%|
|Total tax rate:||7.65%||7.65%||15.3%|
Note that the social security tax rate is applied to a maximum income of $128,400. Also, note that higher incomes may be subject to an additional .9% Medicare rate for Medicare wages earned in 2018.
Self-Employment Tax Deduction: A Small Consolation
While a self-employed person pays twice the Medicare and social security taxes that an employee pays, one small consolation is that the IRS allows the self-employed person to deduct 50% of his/her self-employment taxes from income that is subject to federal income taxes.
Why do I consider this deduction to be a small consolation? Because if you are self-employed and paying, say $4,000 per year more in Medicare and social security taxes than an employee pays, and you are in a 25% tax bracket, the self-employment deduction means you are still paying $3,000 more in Medicare and social security taxes than an employee who is making the same amount of money (a $4,000 deduction would only result in a $1,000 tax savings).
Is that fair?
From my perspective, it's most certainly NOT fair. Unfortunately, there are far more employees than there are self-employed individuals, so we don't have unions and lobbyists fighting for our rights in Washington. Nor do we have the numbers to elect politicians who will represent our interests equal to those of "the entitled" or of the mega-corporations.
But as unfair as self-employment taxes are, I still consider having to pay them as being the lesser of two evils. I would much rather pay an unfair share of taxes than enslave myself to a boss -- especially considering some of the bosses I've had (egos much larger than their IQs).