In addition to income tax, you must pay Social Security and Medicare taxes on your earned income, such as salary and self-employment income. The 12.4% Social Security tax applies only up to the Social Security wage base of $118,500 for 2016 ($127,200 for 2017). All earned income is subject to the 2.9% Medicare tax.
If you’re self-employed, you pay both the employee and employer portions of these taxes.
For employees, these employment taxes are split equally between the employee and the employer. However, self-employed individuals must pay both the employee and employer portions of these taxes on their self-employment income. This tax is calculated and paid as part of their individual income tax return. Estimated tax payments may need to be made to reduce the penalties on these taxes.
Additional 0.9% Medicare tax
Another employment tax that higher-income taxpayers must be aware of is the additional 0.9% Medicare tax. It applies to FICA wages and net self-employment income exceeding $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately).
If your wages or self-employment income varies significantly from year to year or you’re close to the threshold for triggering the additional 0.9% Medicare tax, income timing strategies may help you avoid or minimize it. For example, as a self-employed taxpayer, you may have flexibility on when you purchase new equipment or invoice customers. If your self-employment income is from a part-time activity and you’re also an employee elsewhere, perhaps you can time with your employer when you receive a bonus.
Something else to consider in this situation is the withholding rules. Employers must withhold the additional Medicare tax beginning in the pay period when wages exceed $200,000 for the calendar year — without regard to an employee’s filing status or income from other sources. So your employer might not withhold the tax even though you are liable for it due to your self-employment income.
If you do owe the tax but your employer isn’t withholding it, consider filing a W-4 form to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties. Or you can make estimated tax payments.
Income tax deductions for the self-employed
For the self-employed, the employer portion of employment taxes (6.2% for Social Security tax and 1.45% for Medicare tax) is deductible in calculating your adjusted gross income (AGI). (No portion of the additional Medicare tax is deductible, because there’s no employer portion of that tax.)
As a self-employed taxpayer, you may benefit from other for-AGI deductions as well. You can deduct 100% of health insurance costs for yourself, your spouse and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you’re eligible, an HSA for yourself. Above-the-line deductions are particularly valuable because they reduce your AGI and modified AGI, which are the triggers for certain additional taxes and the phaseouts of many tax breaks. Keep in mind that these deductions will reduce your taxable income, but not your self-employment income.
For more information on the ins and outs of employment taxes and tax breaks for the self-employed, please contact us. To read more about making estimated tax payments, read our article, “What you need to know about estimated tax payments“.