My nephew made the princely sum of roughly $7,000 last year. He correctly calculated that he would owe minimal federal tax (I think it was less than zero after the earned income credit), but he was horrified to learn that he owed the gummint $1100 in social security self-employment punishment tax. He had to sell his computer to raise the money–and working on his computer was how he had earned that $7000 in the first place :mad: (And yes yes yes, he should have known about this beforehand and set the money aside.)
It seemed ludicrous–and unfair–to me that someone who hadn’t earned even close to the poverty level nonetheless owed $1100 in taxes. Does anyone know of any way around this for low income earners, or is my nephew screwed like everyone else? I work as an “independent contractor” as well, and I put that in quotation marks because I have worked for a number of entities in what was clearly an employer-employee relationship (they told me when and where I had to do the work, they had extensive rules about how I would do the work, etc.), but they called me an IC in order to stick me with the employer half of SSI. I couldn’t find a fix for that, either–I had to cough up a huge amount at the end of the year (I filed 1040, Schedule C).
How exactly is he being screwed? I worked for 37 years and I had SS withheld the entire time. As has my husband, and my daughter, and my parents, and my inlaws, and my siblings, and pretty much every person I know who has worked for a living. Exception for those taking unreported income under the table… I’m pretty sure every minimum wage employee in the country pays into SS and Medicare. That’s the way things work in the US.
Seems to me the way to avoid paying a chunk at tax time is to pay-as-you-go.
The self-employment tax is the equivalent FICA taxes that are paid/withheld on an employee’s salary. The only difference is that someone who is self-employed is both employer and employee, so they pay both halves.
The tax is calculated - just like it is with W-2 wages - on earnings before looking at deductions, credits, overall income, etc.
If you were misclassified as an independent contractor when you meet the legal definition of an employee, there are forms SS-8 and 8919 available to correct the problem. If you were not aware of these options, it sounds like to need to obtain the services of a qualified tax professional (my recommendation is to look for someone with CPA or EA credentials).
The money he pays into Social Security funds the Social Security payments he’ll receive later on in life. Many self-employed people don’t set aside money to pay the Social Security and Medicare tax, so they have difficulty paying it when tax season arrives. $7000 times the 6.2% SS withholding rate would be roughly $450 so it looks like he overpaid.
Self-employment tax is 15.3% of 92.35% of net earnings from the business. It’s the employer and employee’s share of both Medicare and Social Security. So the total Social Security portion is 12.4%.
But you’re right about it funding future benefits.
The total amount he must pay for FICA and Medicare is 15.3 percent. On a gross income of $7,000 that is $1,071.
He can complain all he wants but it falls on deaf ears. He didn’t do his homework, all the more infuriating for him because all the answers are easily available from the Social Security Administration and the IRS web sites.
Yep, this is nothing new. One of the sucky parts of self-employment is paying both sides of FICA. (But the employer half you contribute does come off your net income line on your 1040.) Make sure he is getting all the business-related deductions he can on his Schedule C.
Also, do note that he will be required to file quarterly estimated taxes next year if he continues independent contracting and is likely to owe more than $1000 when he files next year.
Punishment? When he’s 85 years old and can’t work and relies upon his contributions to SS so that he isn’t living in poverty (as were the vast majority of seniors before Social Security was established), he’ll be glad he was punished so.
It wasn’t too many years ago that independent contractors paid only about 1.5x the employee rate for SocSec compared with about 2x now. The old way seemed fairer to me.
As for why the first $7000 of income is “taxed” at the maximum rate while income above $114,000 is taxed only for Medicare …
Where have you been?? [del]Don’t you know that Ronald Reagan disproved Marxism single-handedly? Go live in North Korea if you want to steal from the long-suffering Job Creators to appease the lazy poor, you America-hating communist.[/del]
ETA: IRS isn’t so unfriendly. Did you ask them if they’d waive penalty and allow you to schedule payments?
So you think it’s fair that he has to pay twice what “regular” earners pay? OK, obviously you do.
As for when he’s 85, the likelihood of his receiving SSI benefits then, or of SSI existing at all, is effectively zero, so he’ll be paying in most of his life but never will receive anything in return. But that’s a different kind of unfairness.
Yes. And had you been self-employed, you would have paid twice the amount that you did into the system, yet received the exact same benefits. That cumulative excess amount–for which you would have received absolutely nothing–would have constituted quite a thorough screwing. And I daresay you would have thoroughly disliked it.
The “way things work in the US” is that the government hates and despises small business, and the double SSI hit is just one example of that. A regular wage earner would have owed about $550 on my nephew’s earnings. Because he was his own employer, suddenly he owed $1100. Yet, he will receive the same benefits (if he ever receives any benefits at all) as if he had paid in $550. How in any way, shape, or form is that fair?
Well…there is no such contract. But our tax system is supposed to be fair–as is our entitlements system, which this tax we’ve been talking about supports (as in, “props up”). That one person pays twice as much into the system as another, even though both have the same lifetime earnings, and then both receive the same benefits, seems to me to be fundamentally, inherently unfair.
I can’t imagine why anyone would even ask the question why self-employed people pay less tax; their income is taxed at the same rate as wage earners, and they also have to pay the self-employment penalty.
Because they’re running a business and businesses have to pay taxes that regular employees don’t. If that’s objectionable to you or your nephew, don’t start your own business.
But…
If you know what you are doing, you can deduct ALL of the expenses of running your business if you are self-employed. That computer he used to earn his income? Business expense. The electricity to run it, the AC to keep him cool, the floor space for his desk? Business expense. The internet connection? Business expense.
Now, it doesn’t work very well if the business isn’t bringing in enough money to actually have him pay taxes, but real businesses can take advantage of these deductions and do quite well.
Because that wage earner’s employer paid the other $550 - and in some ways , that means the wage earner did in the form of foregone wages. And before you go there, no I don’t mean everyone’s pay would get raised if the employer contribution to SS was eliminated. But the cost of employing someone includes taxes paid by the employer like social security and unemployment, the cost of medical benefits and the cost of any leave. If I’m willing to spend $8000 to employ someone, and payroll taxes will cost me $1000, that person is only getting paid $7000.
