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Did you know that when you're self-employed, you’re thought of by the IRS as both the employee and the employer? Therefore, it’s your job to withhold Social Security from your earnings—contributing the employer’s matching portion of Social Security and the individual’s portion. Instead of withholding Social Security taxes from each paycheck and, because many self-employed people don’t get regular paychecks, you pay all the Social Security taxes on your earnings, when you file your annual federal income tax return. This is both your personal contribution and your business’ contribution.
Investopedia’s recent article entitled “How Social Security Works for the Self-Employed” explains how to calculate the Social Security taxes you owe, if you’re self-employed.
IRS Schedule SE is where you report your business’ net profit or loss as calculated on Schedule C. The federal government uses this information to calculate the Social Security benefits you’ll be entitled to in the future. Self-employment tax consists of both the employee and employer portion of Social Security (6.2% + 6.2% = 12.4%), as well as the employee and employer portion of Medicare (1.45% + 1.45% = 2.9%). Therefore, the total the self-employment tax rate is 15.3%.
If you are self-employed, what you pay in Social Security taxes is derived from your net income. On Schedule SE, you multiply your business’ net profit or loss as calculated on Schedule C by 92.35%, then you see how much self-employment tax you owe.
Note that the CARES (Coronavirus Aid, Relief, and Economic Security) Act lets employers defer employee Social Security taxes through Dec. 31, 2020—50% of the deferred amount will be due Dec. 31, 2021, and the other half by Dec. 31, 2022. Good news: this break also applies to the self-employed.
There are many business expenses that the self-employed can use to decrease their tax liability, in addition to the Social Security tax deductions you can take when you’re self-employed. Business expenses reduce your overall tax, which ultimately lowers your Social Security taxes. These tax deductions are a way of minimizing self-employment tax and Social Security taxes. However, you should know that this can be a negative as far as your Social Security benefit calculations. That’s because these are based in part on your taxable earnings. The more deductions you have, the lower your Schedule C income. Lowering your Schedule C income is a good way to reduce how much federal, state, and local income tax you owe, but that lower amount will be part of your Social Security earnings history. As a result, you may receive lower benefits in retirement, than if you didn’t take those deductions.
There’s no Social Security taxes on your wages that exceed a certain earnings threshold. The wage base for 2020 is $137,700 (up from $132,900 in 2019), and you don’t owe Social Security taxes on your earnings that are greater than that amount.
Social Security really isn’t much different whether you’re self-employed or work for someone else. Self-employed individuals earn Social Security work credits the same way employees do and qualify for benefits based on their work credits and earnings. It’s the business tax deductions that are the biggest difference. If you work for someone else, you pay Social Security taxes on all of your earnings, up to the $137,700 limit in 2020. However, if you work for yourself, deductions you claim on Schedule C can make your taxable income substantially lower. That may decrease your Social Security taxes today, but also may decrease your Social Security benefits later.
Reference: Investopedia (April 29, 2020) “How Social Security Works for the Self-Employed”
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