Question

Be prepared to answer the following:

Compare and contrast employee vs self-employed individual for tax purposes

Answer 1

Self-Employment Taxes

Self-employment taxes are taxes paid by self-employed business owners to the Social Security Administration for Social Security and Medicare, based on earnings from a business you own (not a corporation). Self-employment tax is also called "SECA" tax (from the Self-Employed Contributions Act).

The tax rate for self-employment income is 15.3% for Social Security and Medicare, based on the net earnings of the business. The maximum Social Security earnings are capped, and are set each year; if your Social Security tax exceeds the maximum, no Social Security tax is imposed on the amount over the maximum. Medicare tax is imposed on all net earnings, with no maximum. There is also an additional Medicare tax imposed on higher-income individuals after they reach a specific income level.

Employees only have to pay half of these taxes (employers pay the other half), while business owners pay the entire tax amount. But, business owners may take half the tax off their personal income tax return, to reduce adjusted gross income.

Self-employed business owners pay self-employment taxes, composed of Social Security and Medicare taxes, including the additional Medicare tax, if applicable. And, of course, self-employed people also pay income taxes on the profits from their self-employment

Employment Taxes

According to the IRS, employment taxes include:

• FICA taxes (Social Security and Medicare taxes), based on the employee's income, are shared by the employee and employer. Each pays 7.65%, up to a total of 15.3%. The same Social Security maximum amount applies to FICA taxes. And the additional Medicare tax applies to the Medicare portion of this tax.
• Federal income taxes, which are withheld from employee wages and sent to the IRS by the employer.
• Federal Unemployment (FUTA) tax, which is paid by the employer to provide unemployment benefits to employees. Self-employed individuals don't pay unemployment taxes, and they can't collect unemployment benefits.