Self-employment tax and why the rate doubles
An employee and an employer each pay 7.65 per cent for Social Security and Medicare. A self-employed person pays both halves: 12.4 per cent for Social Security and 2.9 per cent for Medicare, a combined 15.3 per cent on net profit, up to the Social Security wage base of $184,500 for the Social Security portion, plus the 0.9 per cent additional Medicare tax over $200,000.
The offset that takes the edge off
Self-employed workers deduct half of the self-employment tax from gross income before calculating income tax. That deduction reduces income tax but does not reduce the tax itself. On a $100,000 net profit the self-employment tax is roughly $15,300 and the deduction is about $7,650 off the income tax base, worth about $1,700 at a 22 per cent marginal rate. The net cost still sits far above the employee position.
Employee or contractor
The test is behavioural control, financial control and the type of relationship, not what the contract says.
- Who decides when, where and how the work is done.
- Who supplies the tools, and whether the worker can profit or lose on a job.
- Whether the worker has other clients and can advertise.
- Whether there is a written contract and employee-type benefits such as leave or a pension.
Misclassification is common and expensive. A worker treated as a contractor on $70,000 has effectively paid the employer half, about $5,350, out of their own pocket, plus given up overtime rights, unemployment cover and often workers compensation.
The true rate difference
| Item | Employee on $100,000 | Contractor needing parity |
|---|---|---|
| Employer FICA share | Paid by employer | Carried by worker |
| Health premium share | Often heavily subsidised | Full cost, and unsubsidised |
| Retirement match | Common, free money | None |
| Paid holiday and sick | Usually some | Unbilled hours |
| Equipment | Provided | Own cost |
Total those and the break-even contract rate is commonly 35 to 45 per cent above the salary. Quoting a 15 per cent uplift is the most frequent mistake in going independent.
What to withhold for yourself
Set aside between 25 and 35 per cent of every invoice, and pay quarterly estimated tax to stay inside a safe harbour, generally 90 per cent of the current year or 100 per cent of the prior year, to avoid an underpayment penalty.