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Payroll taxes: who pays, how much and how if self-employed

Payroll-tax-paystub

Every salaried worker is well aware of payroll taxes.

These are taxes that come out of our earnings and go toward the Federal Insurance Contributions Act (FICA) programs, or what we know as Social Security and Medicare.

Or, as the old first-time worker joker goes, "Who the heck if FICA and why is he getting some of my money?"

FICA for now: Each FICA component is a percentage of a workers' pay and is paid by both the employer and employee.

The total Social Security tax is 12.4 percent, split evenly between the two tax sources every pay period. The Medicare portion is 2.9 percent, again divided with boss and worker paying half each out of each paycheck.

That comes to the 15.3 percent total, with 7.65 percent coming from the worker's pay and 7.65 percent matched by the employer.

The big difference between the two payroll taxes is that there's a limit on the Social Security collections, but not on the taxes that go toward Medicare.

Each year when a worker's income hits the annual Social Security wage base limit — for 2019, that was $132,900; the annual inflation adjustment bumped that up to $137,700 for 2020 — no more tax is collected for the government retirement benefit.

Is it enough? As the U.S. population ages and concerns grow about the long-term viability of Social Security, the debate has intensified on how to best pay for the programs.

Republicans tend to argue that social programs, which they refer to as entitlements, need to cut, both to keep some form of the benefits available and reduce the growing federal deficits. The Trump Administration's latest budget proposal tends to hew to that policy, seeking cuts in social safety net programs.

Democrats, meanwhile, say tax cuts caused the trillion-dollar deficit, so tax increases on the wealthy, who've benefited disproportionately from the Tax Cuts and Jobs Act (TCJA) changes, are the answer to preserving Social Security, Medicare and other federally funded social programs.

Earnings cap pros and cons: Periodically — OK, all the time — some folks advocate increasing or doing away with the Social Security tax income cap.

Supporters say the added money would boost the Social Security coffers, extending the life of the program, while falling on those who can better afford the tax hit. This approach tends to be the most popular among all proposals to ensure the continued viability of the retirement benefits.

Opponents argue that even if the rich can afford to pay it, eliminating the Social Security tax cutoff amount isn't fair as long as there's the cap on the maximum benefits that are paid to beneficiaries at full retirement age.

BOX In 2020, that's $3,790 a month if you wait until age 70 to take your biggest possible benefit. If you decide to take Social Security at full retirement, which used to be age 65 but now ranges for those born in 1955 or later from 66 years, 2 months to 67 years, the maximum monthly payout this year is, respectively, $2,857 or $3,011. And if you take Social Security at age 62, which generally is the earliest option, the monthly payment tops out at $2,265. END BOX

I know, I know. Commence your income inequality, tax fairness debate now. Comments are open. But for this post's purposes, let's continue with the keep-the-cap arguments.

Higher earners also are more likely to have other income sources to supplement Social Security when they retire. That means that up to 85 percent of their government benefits could be taxed.

Plus, those against removing the wage cap point to the added Medicare contributions that higher earners already make. Affordable Care Act provisions in effect since 2013 have required single taxpayers with earned income of more than $200,000 ($250,000 for married couples filing jointly) to pay an additional 0.9 percent of their earnings in Medicare taxes.

Self-employed payroll taxes, too: The continuing payroll tax debate also is a good time to remind self-employed workers that they are not exempt from payroll taxes.

In order to ensure that every worker, whether they are wage slaves or entrepreneurs, generally must contribute to Social Security and Medicare.

The simplest SE calculation is when you're a sole proprietor, either as your full-time job or by adding a few gigs to supplement your salary. In these cases, you'll file a Schedule C for each of self-employed earnings sources.

Note that if your self-employment earnings are reported as partnership or S corporation income, the SE calculation is more complicated. For this post's purpose, we're focusing on Schedule C income.

Making SE payments: OK, you've filled out Schedule C and your earnings came to $400 or more. That is the amount that triggers SE taxes.

Yes, $400. That amount means that even if you didn't earn enough to actually require you file a tax return, you still could be responsible for making SE tax payments. Parents of teenagers who get summer jobs, take note!

You'll figure and file your SE taxes on the aptly named Schedule SE, which is this week's Tax Form Tuesday featured document.

Since you're both the employee and employer, you must pay both portions to reach the regular 15.3 percent FICA tax total (12.4 percent for Social Security and 2.9 percent for Medicare).

And yes, even if you're self-employed, if you make a lot of money, you'll owe the additional Medicare tax, too.

Don't freak out and don't close down your business. You also get to deduct half the SE amount on Schedule 1.

Short or long options: Schedule SE is a two-page form, but actually it's a combination of two forms.

There's a short SE option on page 1 and a long SE on page 2.

Shcedule SE short form excerpt
Click image to see the full, two-page Schedule SE

If your only income is from self-employment, you'll likely be able to use the short version. That's the six lines on page 1 of Schedule SE (and pictured above).

If, however, you had self-employment earnings as well as wage income, you'll generally need to fill out the long SE, aka section B on page 2.

You can find out which form to use thanks to the flow chart, pictured below and found at top of Schedule SE's page 1.

Schedule SE choice flow chart


The form's instructions (or your tax software or tax preparer) will walk you through whichever version of SE you need to file.

As a self-employed worker, you should be making estimated tax payments. Be sure to factor your SE taxes into these quarterly payments so that when you do file your 1040, Schedule C and Schedule SE you won't face any underpayment penalties.

You also might find these items of interest:

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