Self-employment Tax and Employment Tax
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.
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, in two parts: 12.4% for Social Security and 2.9% for Medicare. The tax amount is based on the the business income of the individual.
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 their adjusted gross income. (They still get credit for the full amount of the self-employment taxes paid, for benefit purposes.)
And, of course, self-employed people also pay income taxes on the profits from their self-employment.
Reporting and Paying Self-Employment Taxes
Self-employment taxes are reported on the business tax return for the owner. Most businesses use Schedule C to report this income as part of their personal tax return. Once you get your business net income, you'll use Schedule SE to calculate and report the self-employment tax.
Self-employment income isn't withheld during the year, so many business owners have to pay quarterly estimated taxes for income tax and self-employment tax. Failing to make these periodic payments can mean IRS penalties for underpayment.
Employment taxes are those paid by employees for federal income tax, FICA Tax (for Social Security and Medicare), and the Additional Medicare Tax. Employers must withhold these taxes from employee paychecks, and then deposit, report, and pay these taxes to the IRS.
Federal income taxes must be withheld from each employee's pay, based on the Form W-4 they must complete at hire and withholding tables.
FICA taxes (Social Security and Medicare taxes), based on the employee's payment amount, are shared by the employee and employer. Each pays 7.65%, up to a total of 15.3%.
Social Security wages are used to calculate the amount of Social Security taxes. The Social Security wage amount may not include some benefits and payments.
Reporting and Paying Employment Taxes
FICA taxes and income taxes that have been withheld from employee pay are reported to the employee by the employer on Form W-2, the annual wage and tax report. The employee then includes this information on their tax return (Form 1040 or 1040-SR).
Federal Unemployment (FUTA) tax is also considered part of employment taxes. This tax is paid by employers to provide unemployment benefits to employees. Self-employed individuals don't pay unemployment taxes, and they can't collect unemployment benefits.
More on Social Security and Medicare Taxes
Social Security earnings are capped, and are set each year; if the Social Security tax exceeds the maximum, no Social Security tax is imposed on the amount over the maximum. This includes employees, their employers, and self-employed individuals. The maximum applies to all earnings, including employee wages and tips and earnings from self-employment.
Medicare tax is imposed on all net earnings of the individual, employee wages, and self-employed individual net income. There is also an additional Medicare tax imposed on higher-income individuals after they reach a specific income level. The additional Medicare tax rate of 0.9% applies to wages, compensation, and self-employment income above a threshold income of $200,000. Employers don't have to pay this additional Medicare tax.
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.
Self-employed individuals pay these taxes based on the income of their business, while employees have these taxes withheld from their paychecks and pay on their individual income tax returns.
IRS. "Self-Employment Tax (Social Security and Medicare Taxes)." Accessed Nov. 5, 2020.
IRS. "Publication 15 (Circular E), Employer's Tax Guide." Page 24. Accessed Nov. 5, 2020.
Social Security Administration. "If You Are Self-Employed." Accessed Nov. 5, 2020.