The best way to understand the difference between the Self-Employment tax (“SE tax”) and the FICA (Federal Insurance Contributions Act) tax is by contrasting self-employment versus regular salary employment. In essence, the SE tax is a Social Security and Medicare tax imposed on individuals who for themselves, while FICA tax is paid in equal portions by employees and employers.
Usually, if you receive a salary by working for someone else, you do not pay the SE tax, but only your half of the FICA tax, which consists of the Social Security and Medicare taxes imposed on employers and employees by the U.S. government to fund Social Security and Medicare programs. Employee’s share of FICA tax consists of 6.2% Social Security tax (in 2010, imposed on up to $106,800 of an employee’s salary) and 1.45% of Medicare tax (no wage limit). The employee’s share of the FICA tax is calculated based on employee’s gross earnings. The other half of FICA tax is also calculated based on the employee’s gross earnings, but it is paid by the employer. Thus, the total FICA tax imposed by the federal government is 15.3% and it is paid in equal shares by employees and employers.
SE tax is a rough equivalent of FICA tax. When you are self-employed, however, you are your own employer. Therefore, the U.S. government imposes a similar 15.3% SE tax on the self-employed individuals, but you are the only one fully responsible for the tax (since there is no employer who would pay one-half of the tax).
In an effort to apparent eliminate tax discrimination between employees (who pay full SE tax) and self-employed individuals (who pay one-half of FICA tax), the federal government created significant differences between the SE tax and the FICA tax. Two of them stand out and deserve special mention in this essay. First, unlike the FICA tax, the SE tax is imposed only on net earnings. Therefore, if you are self-employed, you are able to deduct your business expenses from your self-employment gross income and calculate your SE tax on your net self-employment income. Second, in calculating his adjusted gross income, a self-employed individual is able to deduct a half of his SE tax from his total gross income, further reducing his income tax burden.
Nevertheless, despite these and other differences between these taxes, significant disparity persists. This disparity, however, does not always favor the employees; on the contrary, in many cases, self-employed individuals (especially start-up businesses) are able to make full use of the business expense deductions available to them and significantly reduce their tax burden. Generally, however, once the business matures, the SE tax is felt more heavily by self-employed individuals than employees. In these cases, it is prudent to consult your tax attorney to see what tax planning strategies are available under the Internal Revenue Code to reduce your tax burden.
Sherayzen Law Office can help you correctly assess your current tax situation and help you develop responsible tax planning strategies for you and your business. Call NOW to discuss your tax situation!