I just filled out my tax return and find myself
in a state of shock. I started my own consulting business last year. My net
income on my Schedule C is approximately $50,000. I itemize my deductions to the
tune of about $11,000. I'm single with no dependents. The way I see it, my
income tax is about $6,000. But when I fill out the forms on my computer, I keep
getting something called self-employment tax which is even more than the income
tax! What's going on here? Surely this can't be right?
Bad news, C.K. The self-employment tax you see on your tax return is not a prank played by the makers of your tax software program. It is, instead, the result of a prank played on the American public by the IRS.
This self-employment tax, which your computer program calculated on your behalf, is really Social Security and Medicare tax in disguise. But why is the amount so high? If you were someone else's employee, you would pay only half (7.65¢ of every dollar you earn) the amount of tax you see on your tax return (15.3¢ of every dollar you earn). Furthermore, the amount you would pay as an employee would be withheld from your wages so you would hardly even notice that it is missing.
As a self-employed person, you pay double the amount employees pay. Furthermore, you have to write the check to pay this amount instead of having it surreptitiously removed from your paycheck. The self-employed person actually sees (and feels) how much he is paying in Social Security and Medicare taxes, whereas the employee never gets to touch the money, so it doesn't seem like he is giving up something he once had.
Why is there such a disparity between the amount of tax the self-employed person pays as opposed to the amount the employee pays? Actually, the same amount is paid on behalf of each person. The difference is in the execution of the payment.
The self-employed person pays the entire amount of his Social Security and Medicare tax. If he earns $1,000, he must part with $153 (15.3%). The employee who earns $1,000, has 7.65% or $76.50 withheld from his pay, so he only receives $923.50 of the $1,000 he earned (this calculation is exclusive of any consideration for income tax withholding). His employer sends the withheld $76.50 along with a matching amount of $76.50 to the Social Security Administration on behalf of the employee, for a total of $153, the same the self-employed person pays.
One could argue that the employee who thinks he earns $1,000 actually earns $1,076.50, if you consider the amount of tax his employer must pay on his behalf. This is the way it seems from the employer. s point of view. The employer is required to withhold one-half of the Social Security and Medicare tax from his employees and match that amount with a contribution of his own. He is effectively barred from representing to the employee the true amount of wages paid on his behalf. The employee who earns $1,000 will see nothing on his annual W-2 form reflecting the amounts his employer has paid on his behalf for these taxes.
By forcing the employer to bear the burden of half of these taxes, the employee doesn't feel such a drain on his own earnings. It is the self-employed person who realizes just how much of his hard-earned dollar is being forcibly redirected to the government's retirement program.
And what is the logic behind having the employer pay half of the tax? Only one reason makes sense: Hide the tax so workers won't think their tax rates are too high. Remember that those who created this tax were exempt from paying it government employees hired prior to 1985 did not participate in the Social Security system. Not feeling the pinch of paying for the system themselves, it was easy to enact laws forcing others to participate.
For many years the self-employed person got a break. Rather than paying double what the employee paid, he paid a lesser amount, more than an employee share but not as much as the employee and his employer paid combined. Beginning in 1984 the self-employed person began paying double the amount his employee counterpart paid. A big advantage to being self-employed ended when this occurred.
Because income can be reduced by factors such as exemptions, itemized deductions and contributions to retirement plans for purposes of calculating the income tax, it is not unusual for the self-employed person to find himself paying more in Social Security/Medicare tax than in income tax, as in the case of your tax return. This is a huge adjustment for the former employee who sees this tax on his tax return for the first time.
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