The majority of people who pay into Social Security work for someone else. Their employer deducts Social Security taxes from their paycheck, matches that contribution and sends wage reports and taxes to the Internal Revenue Service (IRS) and Social Security. But self-employed people must report their earnings and pay the taxes directly to the IRS.
You are self-employed if you operate a trade, business or profession, either by yourself or as a partner. You report your earnings for Social Security when you file your federal income tax return. If your net earnings are $400 or more in a taxable year, you must report your earnings on Schedule SE for Social Security coverage purposes, in addition to the other tax forms you must file.
The Social Security tax rate for 2008 is 15.3 percent (the same as 2007) on self-employment income up to $102,000 (it was $97,500 in 2007). If your net earnings exceed $102,000, you continue to pay only the Medicare portion of the Social Security tax, which is 2.9 percent, on the rest of your earnings. There are two income tax deductions that reduce your tax liability. The deductions are intended to make sure self-employed people are treated in much the same way as employers and employees for Social Security and income tax purposes.
First, your net earnings from self-employment are reduced by an amount equal to half of your total Social Security tax. This is similar to the way employees are treated under the tax laws in that the employer's share of the Social Security tax is not considered income to the employee.
Second, you can deduct half of your Social Security tax on the IRS Form 1040 (line 29). This means the deduction is taken from your gross income in determining adjusted gross income. It cannot be an itemized deduction and must not be listed on your Schedule C.
If you have wages as well as self-employment earnings, the tax on your wages is paid first. But this rule is important only if your total earnings are more than $97,500. For example, if you have $20,000 in wages and $30,000 in self-employment income in 2007, you pay the appropriate Social Security taxes on both your wages and business earnings. However, if your 2007 wages are $100,000 and you have $10,000 in net earnings from a business, you do not pay dual Social Security taxes on earnings above $97,500. Your employer will withhold 7.65 percent in Social Security taxes up to $97,500 and 1.45 percent (the Medicare portion of an employee's tax rate) on earnings between $97,500 and $100,000. And you must pay the 2.9 percent Medicare self-employment tax (not the full Social Security tax) on your $10,000 in self-employment earnings.
Please Note: The IRS is the authority on tax matters. For more detailed information on how the self-employed report their earnings, see Tax Information for Small Business/Self-Employed.