Your employer withholds Social Security taxes from each of your paychecks and sends the money to the Internal Revenue Service (IRS) on your behalf when you're hired by and work for a company. You must calculate and remit your Social Security taxes yourself if you're self-employed.
Key Takeaways
- Self-employed workers must pay both the employee and employer portions of Social Security taxes.
- Reducing your income by taking every available deduction will lower your taxes but it will also decrease the size of your Social Security benefits in retirement.
- The amount of your Social Security benefits is calculated based on your 35 highest-earning years.
- The Social Security tax cap for 2024 is $168,600.
- Your Social Security taxes are based on your net income when you're self-employed.
Social Security Taxes
Income of more than $168,600 isn't taxed for Social Security purposes in 2024 but you do have to pay income tax on the full amount of your earnings. This income limit is referred to as "maximum taxable earnings" for Social Security purposes and the cap is adjusted annually to keep pace with inflation.
When You’re an Employee
Your employer deducts Social Security taxes from your paycheck if you work for someone other than yourself. The Social Security tax rate is 6.2% so the amount you’ll pay to Social Security in 2024 will be $10,453.20 or the $168,600 earnings cap times .062 if your annual salary is more than $168,600.
Your company reports your Social Security wages to the government and also pays 6.2% each year on your behalf. The government uses your history of Social Security wages and credits to calculate the benefit payments you’ll receive when you retire.
When You’re Self-Employed
A self-employed person is both the employee and the employer for Social Security purposes so you're responsible for withholding 12.4% in Social Security taxes from your earnings if you're self-employed. You must contribute both the employer’s portion of Social Security (6.2%) and your own portion (6.2%).
This is referred to as the self-employment tax. It also includes your Medicare taxes under the Federal Insurance Contributions Act (FICA). You won’t owe Social Security taxes if you're self-employed and have net earnings of $400 or less.
You can pay the Social Security taxes on your net earnings by making estimated tax payments quarterly or every three months based on how much you think your tax liability will be, both for income taxes and Social Security and Medicare taxes.
You can use IRS Schedule SE: Self-Employment Tax to report your business’s net profit or loss as calculated on Schedule C. The federal government uses this information to determine the Social Security benefits to which you’ll be entitled down the road.
The self-employment tax consists of both the employee and employer portion of Social Security (6.2% + 6.2% = 12.4%) and the employee and employer portion of Medicare (1.45% + 1.45% = 2.9%) for a total self-employment Federal Insurance Contributions Act (FICA) tax rate of 15.3%.
Tax Deductions Can Reduce the Burden
It may seem like you’re getting the short end of the stick when you’re self-employed because you have to pay both portions of the Social Security tax but this isn’t necessarily the case because your Social Security taxes are based on your net income.
Multiply your business’s net profit or loss as calculated on Schedule C by 92.35% before calculating how much self-employment tax you owe. You need only pay the 12.4% combined employee and employer Social Security tax on $92,350 if your Schedule C profit was $100,000. You’d pay $11,451.40 instead of $12,400. This would save you $948.60.
The employer portion of $5,725.70, is also considered a business expense so you can deduct it to reduce your overall tax liability. Report it on line 15 of Schedule 1: Additional Income and Adjustments to Income. Sum it up on line 26 and transfer the total to line 10 of Form 1040. This business expense alone would reduce your taxable earnings to $94,274.30 which you would enter on line 11 of Form 1040 as your adjusted gross income (AGI).
Your total amount of self-employment tax is $11,451.40 and reported on line 4 of Schedule 2: Additional Taxes. You then report any other taxes on the same form and total them. Enter that total on line 18. This is then entered on line 23 of Form 1040, marked “Other taxes, including self-employment tax, from Schedule 2, line 21.
Minimizing Taxes Minimizes Benefits
Many business expenses can reduce your tax liability in addition to the Social Security tax deductions you can take when you're self-employed. “Business expenses reduce your overall tax, which ultimately lowers your Social Security taxes. Business tax deductions are a way of minimizing self-employment tax and Social Security taxes,” says Carlos Dias Jr., founder and managing partner of Dias Wealth LLC in Lake Mary, Fla.
The more deductions you have, the lower your Schedule C income will be. This reduces how much federal, state, and local income tax you owe but keep in mind that the Social Security benefits you’ll receive in the future are based in part on your taxable earnings. This reduced income becomes part of your Social Security earnings history so you may receive lower benefits in your retirement years compared to what you’d receive if you didn’t take all these deductions.
Lower-earning businesspeople could gain more in the future than their higher-earning counterparts due to how Social Security retirement benefits are calculated.
Benefits Are Based on Your 35 Highest Income Years
It makes sense to take all the deductions you can if you have a full 35-year career behind you and you're not earning nearly as much in your current self-employed pursuits as you did back then. Your Social Security benefits will be calculated based on your 35 highest-earning years.
A higher Schedule C income can help you get greater Social Security benefits later if you’re currently in the high-earning part of your career.
It may not be worth the headache to figure out whether you’ll earn more in future Social Security benefits than you’d save by claiming all the deductions you can today. An exception is if you’re on the cusp of not having enough Schedule C income to give you the work credits you need to qualify for Social Security in the first place. It may be worth foregoing some deductions to make sure you qualify for future benefits in this case.
Take Deductions and Invest the Savings
We don’t know what Social Security benefit payments will look like in the future. Growing underfunding could become a problem by 2033 if Congress doesn’t act. This uncertainty suggests that it might be wise to go with the sure thing and take the lower tax liability today. One way to lower your tax liability is to take money out of your business and put it in one of the available retirement plans for the self-employed.
“The great thing about Social Security is you cannot access it until retirement age,”says Kevin Michels, CFP, EA, financial planner and president ofMedicus Wealth Planning. “You can’t make early withdrawals, [but] you can’t skip payments, and you are guaranteed a benefit. However, you have only a small say in the future legislation of Social Security and how it will be affected by the mismanagement of government funds.”
Michels continues:
“If you have trouble saving for retirement already, then paying [as much as allowed] into Social Security may be the better option. If you are confident you can stick to a savings plan, invest wisely, and not touch your savings until retirement, it may be a better idea to minimize what you pay into Social Security and take more responsibility for your retirement.”
If You Fail to File
You still have a limited time to file a return and get credit with the Social Security Administration (SSA) for your work time and income if you don’t file a tax return reporting your self-employment income by the tax deadline. You must file within three years, three months, and 15 days after the tax year in which you earned the income.
You’d have had until April 15, 2024 to correct the situation if you didn’t file a return reporting your 2020 self-employment income but this grace period doesn’t exempt you from any penalties and back taxes you may owe due to filing late.
Threshold Amounts
Let’s say that your 2024 annual earnings are $170,600. The tax rate of 12.4% would be applied to the first $168,600 but not the $2,000 above that. This annual cap applies to both self-employed workers and employees who work for someone else.
Only about 6% of American taxpayers exceed the tax cap each year.
Qualifying for Social Security Benefits
You'll need 40 Social Security work credits, the equivalent of 10 years' work, to qualify for Social Security benefits. You earn one credit for every quarter in 2024 that you earn at least$1,730. The number changes annually.
It’s not difficult to earn the Social Security credits you need even if your business isn’t particularly successful or you only work at it part-time or occasionally. Some alternative ways allow you to earn Social Security credits should your earnings fall below this threshold or if your business should suffer a loss. These optional methods may increase the amount of self-employment tax you owe but they’ll help you get the work credits you need.
Don’t count on getting a large Social Security check in retirement if you never earned much money from a lifetime of self-employment. Specific categories of earnings don’t count toward Social Security for most people whether they're self-employed or employed. These include stock dividends, loan interest, and real estate income. You don’t pay Social Security taxes on this income and it isn’t used to calculate your future benefits.
An exception exists if your business operates in a field where this rule doesn't apply. Self-employed stockbrokers do count stock dividends toward their Social Security earnings.
Do I Pay Social Security If I Am Self-Employed?
Yes, you do. Those who are new to working for themselves should know that their past employer paid half their Social Security contributions and they paid the other half. You're both the employer and employee now that you're self-employed so you're responsible for making the entire Social Security contribution amount yourself.
Can I Check on My Social Security?
You can check your Social Security contributions and award status by logging onto the Social Security website and creating an account.
When Are You Eligible for Social Security Benefits?
You're eligible for benefits at the age of 62 but you'll receive a reduced amount if you start taking them that early. Those who wait until age 67 will collect the full amount to which they’re entitled if they were born after 1960. Those who wait until age 70 will see their benefit amount increased by 24% or 8% for each year after 67. Benefits stop increasing after age 70.
The Bottom Line
The qualifications for Social Security are the same whether you’re self-employed or work for someone else. Self-employed individuals earn Social Security work credits the same way employees do but self-employed workers pay the full 12.4% tax rate. Those who are employed by others pay only 6.2%. Their employer pays the other half.
Deductions you claim on Schedule C can lower your taxable income if you work for yourself. This will decrease your Social Security taxes in the present but it could lower the amount of your future Social Security benefits.
