If you work to earn your money (as opposed to receiving your money through dividends, trusts, gifts, etc.), you have to pay Social Security and Medicare taxes.1
Social Security and Medicare together constitute your “self-employment tax.”
You only pay self-employment tax (Social Security and Medicare) for net income you earn through work.2
You pay self-employment tax in addition to income tax. Income tax is broader than the self-employment tax, applying to all the income you receive, regardless of the source.3
So, for your compensation income, you pay both employment tax and income tax.
Pay it Quarterly
Like you, employees also pay taxes for Social Security and Medicare. However, the process of paying is easier for employees than it is for the self-employed. For employees, their employer simply takes the money out of each employee’s paycheck and passes it on to the federal government.
If you are self-employed or you work as an independent contractor, you do not have the “benefit” of an employer to withhold and pay the tax for you.
You must calculate the self-employment tax yourself and pay it along with your income tax when you make your quarterly estimated tax payments.4
The Cost to You
For you (as a self-employed individual), you pay 12.4 percent for Social Security tax, up to a certain dollar amount of your income.5
In 2017, the Social Security Administration set the taxable income limit at $127,200, meaning you do not pay tax on income you earn in excess of that amount. Thus, the most you could pay in Social Security tax in 2017 would be $15,772.80 (12.4% x $127,200).6
You also pay Medicare tax, which is 2.9 percent of your income.7
There is no upper limit to the Medicare tax. Instead, for income over $200,000, you must pay an additional 0.9 percent.8 (For joint filers, the additional tax kicks in at $250,000, and for married filing separately, at $125,000.)
Take a Deduction
Employees have another advantage over independent contractors. Their employers pick up half the bill.
Unlike you, employees pay 6.2 percent for Social Security (versus 12.4 percent for you) and 1.45 percent for Medicare (versus 2.9 percent for you).9
To (partially) make up for this unfairness, you get to deduct half of your self-employment tax when you calculate your income taxes.10
Employees with a Side Business
If you work as an employee but also have self-employment income, you will have to take your withheld employee income into account when you calculate your self-employment taxes.11
For example, the Social Security wage base applies to all work compensation income, whether your earn it as an employee or from self-employment.
Thus, if you earn $60,000 as an employee and $70,000 in your side business, you only pay Social Security tax on $127,200 of that income.
1 IRC Section 1401.
2 IRC Section 1402(a).
3 IRC Section 61.
4 See Form 1040-ES.
5 IRC Section 1401(a). The tax code refers to the Social Security tax as the tax for old-age, survivor and disability insurance (OASDI).
6 See the SSA’s website for the current income limit for the tax.
7 IRC Section 1401(b)(1). The tax code refers to the Medicare tax as the tax for hospital insurance (HI).
8 IRC Section 1401(b)(2).
9 IRC Section 3101(a) and (b).
10 IRC Section 164(f).
11 IRC Section 1402(b).