In addition to income tax, you must pay Social Security and Medicare taxes on earned income, such as salary and self-employment income. The 12.4 percent Social Security tax applies only up to the Social Security wage base of $118,500 for 2016. All earned income is subject to the 2.9 percent Medicare tax.
The taxes are split equally between the employee and the employer, but if you are self-employed, you pay both the employee and employer portions of these taxes on your self-employment income.
Additional 0.9 percent Medicare tax
Another employment tax that higher-income taxpayers must be aware of is the additional 0.9 percent Medicare tax. It applies to Federal Insurance Contributions Act (FICA) wages and net self-employment income exceeding $200,000 per year ($250,000 for married filing jointly and $125,000 for married filing separately).
If your wages or self-employment income varies significantly from year to year or you are close to the threshold for triggering the additional Medicare tax, income timing strategies may help you avoid or minimize it. For example, as a self-employed taxpayer, you may have flexibility on when you purchase new equipment or invoice customers. If your self-employment income is from a part-time activity and you also are an employee elsewhere, perhaps you can time with your employer when you receive a bonus.
Something else to consider in this situation is the withholding rules. Employers must withhold the additional Medicare tax beginning in the pay period when wages exceed $200,000 for the calendar year without regard to an employee’s filing status or income from other sources. So your employer might not withhold the tax even though you are liable for it due to your self-employment income.
If you do owe the tax but your employer is not withholding it, consider filing a W-4 form to request additional income tax withholding, which can be used to cover the shortfall and avoid interest and penalties. Or, you can make estimated tax payments.
Deductions for the self-employed
For the self-employed, the employer portion of employment taxes (6.2 percent for Social Security tax and 1.45 percent for Medicare tax) is deductible above the line. (No portion of the additional Medicare tax is deductible, because there is no employer portion of that tax.)
As a self-employed taxpayer, you may benefit from other above-the-line deductions as well. You can deduct 100 percent of health insurance costs for yourself, your spouse, and your dependents, up to your net self-employment income. You also can deduct contributions to a retirement plan and, if you are eligible, a health savings account (HSA) for yourself. Above-the-line deductions are particularly valuable because they reduce your adjusted gross income (AGI) and modified AGI (MAGI), which are the triggers for certain additional taxes and the phaseouts of many tax breaks.
For more information on the ins and outs of employment taxes and tax breaks for the self-employed, please contact us.