Self-employment Tax and Employment Tax - What's the Difference?
For small business owners, the complexity of taxes is almost overwhelming. Taxes associated with employees are the most confusing. This article attempts to sort out one of these confusions: the terms "self-employment tax" and "employment tax."
The basic difference between these two terms is that self-employment tax is paid by self-employed individuals, while employment taxes are paid by employees and their employers.
What are Self-employment Taxes?
Self-employment taxes are taxes paid by self-employed business owners to the Social Security Administration for Social Security and Medicare, based on earnings from a business you own (not a corporation). Self-employment tax is also called "SECA" tax (from the Self-Employed Contributions Act).
The tax rate for self-employment income is 15.3% for Social Security and Medicare, based on the net earnings of the business. The maximum Social Security earnings are set each year; if your Social Security tax exceeds the maximum, no Social Security tax is imposed on the amount over the maximum. Medicare tax is imposed on all net earnings, with no maximum. There is also an additional Medicare tax imposed on higher-income individuals, after they reach a specific income level.
Employees only have to pay half of these taxes (employers pay the other half), while business owners pay the entire tax amount. But, business owners may take half the tax off their personal income tax return, to reduce adjusted gross income.
Self-employed business owners pay self-employment taxes, composed of Social Security and Medicare taxes, including the additional Medicare tax, if applicable. And, of course, self-employed people also pay income taxes on the profits from their self-employment.
What are Employment Taxes?
According to the IRS, employment taxes include:
- FICA taxes (Social Security and Medicare taxes), based on the employee's income, are shared by the employee and employer. Each pays 7.65%, up to a total of 15.3%. The same Social Security maximum amount applies to FICA taxes. And the additional Medicare tax applies to the Medicare portion of this tax.
- Federal income taxes, which are withheld from employee wages and sent to the IRS by the employer.
- Federal Unemployment (FUTA) tax, which is paid by the employer to provide unemployment benefits to employees. Self-employed individuals don't pay unemployment taxes, and they can't collect unemployment benefits.
What If I Have Both Self-employment Income and Employment Income?
What if I am both self-employed and an employee? Do I have to pay the maximum on both self-employment tax and employment tax? Yes and no. You must pay income tax on income from all sources, including both self-employment income and employment income. You will have to pay both self-employment tax (SECA) for Social Security and Medicare, and also your employer must collect FICA taxes from your wages. But there is a maximum on the Social Security tax,
In general, FICA taxes from employment are considered first, and if the Social Security maximum has not been reached, self-employment taxes are included. This article on SECA and FICA taxes explains in more detail how these taxes work in this situation.
Except for federal unemployment benefits, both self-employed individuals and employees pay the same taxes - federal income taxes and taxes for Social Security and Medicare. As I said in the beginning, these are essentially the same taxes, just with different names.