Company employees who routinely receive regular paychecks understand that certain taxes are withheld from their paychecks with every payroll cycle. They may not understand what those taxes are for, but they certainly understand that what they are finally paid does not equal what they have actually earned. Things are different for the self-employed.
Self-employed individuals pay their own taxes. Nothing is withheld from the payments they receive from customers. So where a company employee has the luxury of paying FICA through paycheck withholding, self-employed people have to pay FICA directly.
Are you self-employed? If so, do you understand the whole FICA system? If not, this post offers an overview by way of three things every self-employed person needs to know about FICA:
1. What It Is
Federal law requires employers to withhold and pay three different kinds of employment taxes. These include Social Security tax, Medicare tax, and a Medicare surcharge on certain qualifying employees. For the purposes of this post, we will only deal with the first two.
FICA is essentially a combination of both Social Security and Medicare taxes. Those taxes go to fund payments made to current Social Security and Medicare recipients. That means for company employees, a certain percentage of the money withheld from their paychecks is going to pay current Social Security recipients. Another portion is going to fund the Medicare program.
2. How it is Calculated
The next thing self-employed people need to know is how FICA is calculated. It is a fairly straightforward calculation based on a percentage of earnings. Right now, Social Security is taxed at 12.4%. Both the employer and employee pay half. The employee’s half is withheld from his or her paycheck, deposited into a tax account, and paid along with the employer’s share on a regular schedule.
Medicare tax is currently assessed at 2.9%. Again, it is divided equally between employer and employee. The same withholding and payment method apply as well.
3. How the Self-Employed Pay
The third thing to know is the most important for self-employed individuals, explains Dallas-based BenefitMall. It is based on the fact that a self-employed person is both an employer and an employee. Guess what that means? The self-employed get to shoulder the entire FICA bill.
Let’s say you are a freelance graphic designer. You work as a sole proprietor, picking up clients as you go. Your company has no payroll department, no HR department, and no other employees except you. You are your only employee.
Unfortunately, the IRS wants it both ways with you. All of your business income is treated as personal income for tax purposes. You do not get the benefit of differentiating between business revenue and personal income. At the same time, you don’t get to skate by without having to pay the employer’s portion of FICA.
As a self-employed individual, you pay the full 12.4% for Social Security taxes and the full 2.9% for Medicare. This may seem a bit unfair, but it is what it is. For the record, you pay FICA right along with your estimated income taxes. Payments are made quarterly in most cases.
4. FICA Is Mandatory
Finally, the self-employed need to understand that FICA is mandatory. The only exception is given to certain kinds of religious workers that meet one of several different exemptions. If you are not one of those workers, you do not have a choice. You are required to pay FICA as part of your regular estimated taxes. Fail to pay it and you will have a hefty tax bill at the end of the year.