How Does Self Employment Affect Social Security?
Self-employment lasts a lifetime for some individuals, and payment of Federal Income Contributions Act taxes, or FICA taxes, becomes a quarterly or yearly process. These are Social Security taxes, your future retirement income. The rate in 2010 totals 15.3 percent or 6.2 percent for Social Security and 1.45 percent for Medicare. The rate may change with new legislation. Because you are both employer and employee, you pay double the amount but subtract some of it from your income taxes.
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Payment of FICA Taxes
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FICA taxes for self-employed are calculated on net income. If you are an employee, your FICA taxes are 7.65 percent paid by you and 7.65 matched by your employer, paid on your income totals. The Social Security portion, or 6.2 percent, stops once you reach $106,800 in income. The Medicare portion, or 1.45 percent, has no limitations. Your FICA tax based on income after subtraction of your expenses may be much lower for you as a self-employed person than if you were an employee. You may pay FICA taxes with your Form 1040 if you do not have to file a quarterly report. Prepare Schedule C for your business and file Schedule SE for self-employment taxes if you have net income in excess of $400.
Result of Low FICA Taxation
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Every year, Social Security sends a statement of work credits and your income as recorded in their files. Social Security bases your benefits on 35 years of income, and if your income is low for many years, your monthly Social Security benefits will be low when you retire. You must have 10 years or 40 credits of income to qualify for Social Security benefits. Your total net income must be $4,480 or more to make the four credits for the year. Individuals who are self-employed and do not report all their income cheat themselves on Social Security retirement.
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Self-Employment Taxes
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Self-employment taxes continue if you continue working even after you've started collecting Social Security and Medicare. If you earn net income in excess of $400, you must pay FICA taxes as a sole proprietor of a part-time business. These taxes pay for others who come behind you, just as others pay for benefits you collect. Whether you are a sole proprietor or an independent contractor, you pay FICA taxes on net income. The form allows you to subtract 7.65 percent, the amount of the tax you pay as an employer. Line 4 or 4a on the Schedule SE, depending on whether you file a long or short form, requires multiplication by .9235 to give you that break.
Effects of Self-Employment
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Over a lifetime of self-employment, a successful business may give you the maximum FICA payment into the Social Security system each year, resulting in the maximum benefit at full retirement age. Most self-employed individuals need to plan for retirement with an individual retirement account or some form of savings for the future. Social Security estimates that benefits only cover about 40 percent of the pre-retirement income and that retirees need 70 to 80 percent of pre-retirement income. You will need to match Social Security funds or provide at least half of your retirement income. You won't have a company pension plan unless you create one for yourself.
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