Ordained :: Employee vs. Self-employed

Girl on ComputerI’ll just tell you right up front, this isn’t going to be the most fun post to read. It’s got a bunch of accounting / tax / nerd stuff in it. BUT, it’s useful information. So, here goes…

If you want, you can take notes like this girl
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Social security taxes are collected under two separate tax systems:

  • FICA (Federal Insurance Contributions Act) – where half the tax is paid by the employee and the other half is paid by the employer.
  • SECA (Self-Employment Contributions Act) – where the total tax is paid by the self-employed person.
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    The IRS treats all commissioned employees as self-employed for purposes of social security taxes, but as employees for purposes of state and federal income taxes.

    For 2007 FICA, the employee’s share of the Social Security portion of the tax is 6.2% of gross compensation up to a limit of $97,500 of compensation. The employee’s share of the Medicare portion is 1.45% of wages with no limit. The employer is also liable for separate 6.2% Social Security and 1.45% Medicare taxes making the total Social Security tax 12.4% and the total Medicare tax 2.9% of wages.

    For 2007 SECA, self-employed people are responsible for the entire FICA percentage of 15.3% (= 12.4% + 2.9%), since they are both the employer and the employed; however, the 15.3% multiplier is applied to 92.35% of the business’s net profit, rather than 100%; the difference, 7.65%, is half of the 15.3%, and makes the calculation fair in comparison to that of regular (non-self-employed) employees. It does this by adjusting for the fact that the employees’ 7.65% share of their FICA tax is multiplied against a number (their gross income) that does not include the employer’s half of their FICA tax. In simpler words, it makes the calculation fair because employees don’t get taxed on their employers’ contribution of the second half of FICA, therefore self-employed people shouldn’t get taxed on the second half either. Similarly, self-employed people also deduct half of their self-employment tax (schedule SE) from their gross income on the way to arriving at their adjusted gross income (AGI). Again, this evens the playing field with regard to regular employees, who don’t pay general income tax on their employers’ contribution of the second half of FICA, just as they didn’t pay FICA tax on it either.

    Clear as mud right?

    One Trackback

    1. By Ordained :: Employee vs. Self-employed on May 6, 2008 at 9:26 am

      [...] agung wrote an interesting post today onHere’s a quick excerptIt’s got a bunch of accounting / tax / nerd stuff in it. BUT, it’s useful information. So, here goes… If you want, you can take notes like this girl [...]

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