Friday, January 16, 2009


It seems that Tim Geithner, BO’s choice for Secretary of the Treasury, has replaced Joe the Plumber as the most talked-about taxpayer (or in this case – tax non-payer) of the moment. Geithner’s situation has brought attention to the issue of the Self-Employment Tax.

All workers are required to pay into the Social Security system – unless you work for the government or some non-profit organizations. Employees have FICA (Social Security and Medicare) Tax withheld from their wages. Employers must match the amount withheld. Individuals with “net earnings from self-employment” pay the Self-Employment Tax – which is actually FICA Tax. However they must pay “both halves” of the FICA tax (the equivalent of the employee’s share and the employer’s share).
Where a W-2 employee pays 7.65% of wages (up to the statutory maximum – at which point they pay 1.45% on the excess earnings) a self-employed individual pays 15.3% (up to the same maximum – at which point they pay 2.9% on the excess).

In reality self-employed individuals actually pay only 14.13% on “net earnings from self-employment”, as the 15.3% is only applied to 92.35% of their net Schedule E (or K-1) earnings. Plus they are allowed an “above-the-line” deduction for ½ of their Self-Employment Tax – so the actual effective tax rate depends on their federal income tax rate. taking into account the 50% self-employment tax adjustment to income, the “effective” cost of your self-employment tax is –

* 15% Bracket = 13.07%
* 25% Bracket = 12.36%
* 28% Bracket = 12.15%

The “Fix The Tax Code Friday” topic at Kelly Phillips Erb’s TAXGIRL blog today is “Fix the Tax Code Friday: SE Tax”. She asks the question – “Should self-employed persons be allowed to opt out of paying self employment tax (and thus, collecting Social Security benefits and the like)?”.

In my comment on the question submitted at TAXGIRL I said that “My answer is yes – but only if “normal” W-2 employees were similarly able to “opt out” of Social Security. As long as one class of worker is required to participate it should be mandatory for all classes.

I also support private Social Security accounts – not invested in the stock market, but in the money market or Treasury securities market.”

If I was able to invest all the money that I paid into the Social Security system over the years, and all future payments, in a 5% money market account or bank CD I would have a lot more money at retirement than I will be collecting from Social Security.

In addition – if I apply for Social Security and get my first check and then drop dead the next day, all the money I paid into the system will not go to my beneficiaries but to other SS recipients. All the money will be lost! If I had instead invested the money in a private account the balance would pass on to my sister and other relatives.

My comment goes on to say – “The self-employment tax calculation should be corrected to bring it in line with the treatment allowed a one-man corporation. In a one man corporation all employee benefits provided to the owner, like health insurance and pension contributions, reduce {the money available to pay} the owner’s salary. FICA tax is only assessed on the actual salary.

With a self-employed individual, the SE tax is imposed on net profit of the business before deducting the self-employed health insurance premiums and pension contributions for the self-employed person and the ½ of SE tax.

Owner health insurance premiums and pension contributions should be Schedule C deductions and not adjustments to income.”

In the case of two self-employed individuals with the exact same income and expenses – one filing Schedule C and one incorporated – the Schedule C filer will pay a lot more in Self-Employment Tax than the incorporated business owner will pay in employee and employer FICA tax. Is that fair?

So how would you answer Kelly’s question – and what do you think of my suggestions?


RLMCPA said...

Thanks for your calculations regarding the effective cost of self-employment tax. I've referred my clients to your blog.

What is the effective cost at the 33% tax bracket?

Robert D Flach said...


Thanks for spreading the word about THE WANDERING TAX PRO.

The effective cost in the 33% bracket would be 11.8%.


Anonymous said...

If I have fica that was paid to the maximum from my employer and I am now self employed to I still have to continue paying that portion of the sele employed tax even though I know I have already exceeded the maximum fica owed for 2012?

Robert D Flach said...


The self-employment tax is calculated on Schedule SE, an attachment to the Form 1040.

If you have already maxed out on Social Security wages on a Form W-2 you would use Page 2 of the Form SE to calculate the self-employment tax liability.

The calculation on Page 2 of Schedule SE takes the Social Security wages reported a Form W-2 into account when determining the liability.

You will not be "double-taxed".