Ever since I started working as a summer intern, I have always been depressed to open up my check and see the amount of my salary that was going towards taxes. Currently, 29.2% of my salary goes straight to the government. The majority of my taxes are federal income taxes, with social security tax and state income tax coming in second and third. Medicare taxes are a distant fourth. The magnitude of the downsizing of my income due to taxes is even more readily apparent on my self-employed income.
Double the Taxation
As a part-time self-employed contractor, I am responsible for federal and state income taxes, as well as a double taxation on the Federal Insurance Contributions Act (FICA) taxes, social security and Medicare. The employer and employee are each responsible for paying half of the Medicare tax and social security tax. As a self-employed contractor, I am responsible for both the employer’s and employee’s portions of the Medicare tax and social security tax. This double taxation is the major reason why I set the goal to put all of my self-employed income into a solo 401k. I wanted to defer the taxes on my self-employed income, since it will be taxed at such a high rate due to this double taxation.
Breaking Down the Tax Rates
The combined tax rate for the FICA taxes is 7.65% for regular income and 15.30% for self-employed income in 2008. The social security portion of the FICA tax is 6.20% for regular income and 12.40% for self-employed income in 2008. The Medicare portion of the FICA tax is 1.45% for regular income and 2.90% for self-employed income in 2008.
Social Security Wage Limit
The Medicare tax has no income caps, however, the social security tax has an income cap of $102,000 for 2008. This means, that if your combined income exceeds $102,000, the portion of your income above $102,000 is not subject to the social security tax. This is a very critical income cap to exceed if a portion of your income is self-employed as you are saving 12.40% of the taxes on your income, instead of just 6.20%. The wage limits for the social security cap increase yearly based on a Cost of Living Adjustment (COLA). The following table shows the increases in the wage limits over recent years.
As you can see, the wage limit has increased every year since at least 2000. The average increase in the wage limit is 3.7%, however, the average COLA is 2.8%. The difference in almost one full percentage point means that if you are getting annual salary increases that match the cost of living, you are falling further behind the wage limit and further away from decreasing your tax rate on your self-employed income.
Currently, my salary does not exceed the wage limit, and I don’t make enough self-employed income to fret too much over this ever increasing wage limit. I have thought about trying to extend my self-employed income as a tutor, however, I am about a year away from trying to do that. The wage limit is definitely something I’m shooting for as it is critical to self-employed individuals and I’m hoping I have significant self-employed income in my future.