3

This is a USA tax question.

Preparing my taxes (regular form 1040), I noticed that the "Other Taxes" section comes after the "Tax and Credit" section. I have some "wages, salaries, tips" income, some self-employment income and some tax credits I am able to take. The relative numbers of these are such that my tax on my "normal" income (written on line 47 of the form) is less than the maximum tax credits I can access on lines 48-54, so my "normal" income tax burden is zero with some "wasted" credits that then apparently can't be applied toward my self-employment tax (line 57).

I'm wondering, why is that? (If such an answer can even be found.) Why would some tax credits not be applicable to self-employment tax?

3

Self-employment tax is actually a completely separate tax from income tax. It is only included on the income tax form for convenience.

6

Self-employment tax is the same as Social Security and Medicare withholdings on W2 income (commonly called FICA or payroll taxes), with W2 income employers pay half and you pay half. For those who are their own employers, they bundled the full amount of Social Security and Medicare together as self-employment tax when SECA was passed years after FICA was passed. Neither gets refunded unless an error was made and too much was withheld.

Why are these treated differently than income tax? FICA stands for Federal Insurance Contributions Act and SECA stands for Self Employed Contributions Act. Calling it a contribution may sound like their way of avoiding calling it a tax, but it does denote some difference from other taxes. You could think of it like a tax that's also an insurance premium. Taking it near the top ensures contribution/participation from almost all earners (there are groups exempted, but typically not paying means not benefiting as well).

3

Suppose first that you have no self-employment income and so your taxable income is entirely due to salary, wages, interest, dividends, capital gains etc.. Lines 48-54 are tax credits that reduce the income tax (plus AMT if any) that you owe on your income, and you cannot use the total credits of Line 55 to reduce the Social Security tax and Medicare tax on your salary or wages even if the total credits (Line 55) are more than the income tax you owe. As the instructions for line 55 say, "If Line 55 is more than Line 47, enter -0-", and you have "wasted" all the extra credits on Line 55 without getting back any of the Social Security and Medicare taxes that were withheld from your salary; you get only a refund of all the income tax that was withheld.

Now, suppose that you also have self-employment income. The income gets reported on Line 12, and it is the net profit from your self-employment business without having any taxes taken out of it.

  1. The Social Security and Medicare tax that you (as the employer) have to pay is a business tax that has not been collected as yet and so what you paid yourself as the employee includes the amount of this business tax as well, and you (the employer) are trusting yourself (the employee) to forward this money to the Social Security administration on your behalf.
  2. You (the employer) are trusting yourself (as the employee) to also send to the Social Security Administration the Social Security and Medicare tax that you (the employer) were supposed to withhold from the employee's wages but didn't.
  3. You (the employer) are also trusting yourself (as the employee) to send to the Treasury the income tax that you were supposed to withhold from the employee's wages, but didn't.

Well, Items 1 and 2 are computed on Schedule SE and reported on Line 57. You have to pay these amounts regardless of whatever tax credits you might have, just as is the case of regular salaries that you receive from someone else; you don't get a refund of Social Security and Medicare tax withheld from your salary or wages regardless of tax credits, nor do you (or your non-you employer) get a refund of Social Security and Medicare tax paid by your employer. What about Item 3? Well, your self-employment income is included in your AGI and is taxed appropriately. If you have lots of tax credits, your self-employment income might escape income tax entirely, just like your salary or wages, but extra credits don't get you back the Social Security and Medicare taxes; they are not refunded.

But wait a minute: some of the money that you (the employee) got from your ...hole employer (yourself) was Social Security and Medicare tax on the employer that you, the employee, are just passing on to the Social Security Administration on the employer's behalf. No fair that you should have to pay income tax on that money! Let the ...hole pay income tax on that! Well, you, the employee, don't pay any income tax on that money. Item 1 (as computed on Schedule SE) is backed out of your AGI on Line 27 and so it is not included in your taxable income. But what about yourself, the employer? Well, As an employer, your business has zero profits, because all the money that your business made was paid to you wearing the employee hat, and so no income tax is due from you, the employer. What tax that you (the employer) have to send to the government (employer's share of Social Security and Medicare tax, Social Security and Medicare tax that you are supposed to have withheld from your employee's wages but didn't, income tax that you are supposed to have withheld from your employee's wages but didn't) has all been passed on to your employee to send to the government on your behalf.

  • Thanks, this makes a lot of sense. To summarize, if I understand correctly: You still owe tax on the income just as would have been withheld from your paycheck if you were employed; in particular the portion of the tax which was not deductible in the first place. – Kai Apr 13 at 15:13

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