Self Employment Tax Calculation

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Social Security And Medicare 15.3% Sole Proprietor Taxes On 2009 IRS 1040SE

Warning: These pages are not intended as professional advice. They are presented "as is", reader beware!

If you earn over $400 in your business as a self employed sole proprietor, you have to file Schedule SE as part of your 1040 tax return. Most of us can file the short form of Schedule SE, the long from for those who need it appears on the back of the short form and brief instructions. The main thing that will kick you into having to file the long form is if you also received regular wages during the year over $106,800 (2009) or if you received tips waiting tables you didn't report. Being a church employee can also force you into the long form, as well as being a minister who runs another business, or using an optional method to calculate your net earnings.

You have to complete Schedule C before you fill out Schedule SE because the first thing you need to know is the net profit from your sole proprietorship. The net profit from any and all businesses (farm partnerships and ministers need to file additional forms) are added up to reach your net income from self employment. The form than takes you through a few simple math operations that we'll explain after the fact. First, you multiply your total self employment income by 0.9235, which is the same as taking 92.35% of the total. Next, you multiply that sum by 0.153 (taking 15.3%), for amounts under $106,800. For the 2009 tax year, the IRS doesn't collect the Social Security contribution over the $106,800 barrier, so the total you owe is the amount already computed plus the continuing Medicare contribution above $106,800. You can get that by multiplying the remaining income by 0.029 (taking 2.9%), and add it to the 15.3% tax. But the way the IRS has you do it is to instead multiply the total amount by 0.029, and then add the fixed sum of $13,243.20 - assuming I did the math right. The final step is to multiply the total self employment tax by 0.5, which gives you the Schedule 1040 deduction for half the self employment tax you pay.

Now let's go back and take a look at the social security tax calculation in slow motion. First of all, where do these numbers come from? As payroll taxes are currently assessed in the US, employers must pay 6.2% of employee compensation as a social security contribution up to $106,800 in 2009, and the employee sees the same amount deducted from their check. So the total social security tax on payroll is 12.4% of monies paid, but excludes certain protected compensation, most notably health benefits. Next the employer must contribute 1.45% of employee compensation to Medicare (again with certain benefit exclusions) but without any upper limit, and the employee matches this contribution to bring the Medicare tax up to 2.9%. Finally, adding the 12.4% to the 2.9% gets us to the 15.3% that a self employed sole proprietor pays in self employment taxes on income under $106,800.

But remember the first step of the calculation, where we reduce the total net income to 92.35% of the initial amount. The 7.65% of your self employment income that isn't taxed for social security and medicare is the IRS acknowledging that something unfair is going on here, and you shouldn't pay a tax on money you never received because it was taken as either your employer or employee contribution. The logic as to why they exclude just half makes no sense to me, and it turns out to be a regressive tax, because the highest earners get the greatest benefit. For example, somebody earning right up to (or over) see the amount of their income subject to self employment tax reduced by a much larger amount than somebody earning at the poverty level. The percentage is the same, the load is uneven.

However, this deduction is relatively small and not nearly as regressive as the deduction for one half the self employment tax taken on the form 1040. A sole proprietor with a low income, or with a family, mortgage, etc, is likely paying tax in the 10% income bracket. A sole proprietor earning well over $100,000 is paying income tax in a bracket over 28%, as high as 35%. What make the deduction regressive is that the well-off sole proprietor gets to deduct between 28% to 35% of half the self employment tax paid from his ultimate IRS bill. The low income sole proprietor deducts only 10% of half the self employment tax paid, when both paid self employment tax at the same rate.

For what it's worth, these days my business income doesn't fall very short of the upper limit on social security tax each year, but I remember all of those years when I was just getting started as a sole proprietor and paying 15.3% of my sub-$10,000 a year income always felt wrong in a country that wants to encourage entrepreneurship.

Planning A New Business | Estimating Business Taxes | Schedule C Deductions | Car Expenses | Freelancer and Contractor Payments | Section 179 Depreciation and Form 4562 | Employee Benefits and Pension Costs | Professional Services, Business Taxes and Fees | Hotel and Travel Expenses | Deducting Food and Entertainment | Inventory and Cost of Goods Sold | Sole Proprietor Statistics | Home Office Deductions | Self Employment Tax | The Self Employed Sole Proprietor