The Self-Employment Contributions Act (SECA) of 1954 is a tax law that requires the owners of small businesses--such as S corporations, partnerships, and sole proprietorships--to pay a tax of 15.3 percent of their net income from self-employment to cover their own Social Security, Medicare, and Old Age Survivors and Disability Insurance (OASDI) costs. Workers who are employed by a company or another person (rather than being self-employed) only have to pay half of this amount, which is withheld from their paychecks. Their employer pays the other half. In effect, SECA requires self-employed persons to pay both the employer and employee portions of the Federal Insurance Contributions Act (FICA) tax (a combination of Social Security and Medicare). To make this situation more equitable, small business owners subject to SECA are allowed to deduct half of their SECA tax amount on their personal federal tax returns.

SECA taxes are paid on self-employment income after costs associated with the activity have been deducted. The Internal Revenue Service refers to this as net profit (or loss), usually reported on Schedule C of Form 1040. Thus the base amount used for SECA calculation is profit before taxes. The first step in calculating the SECA is to multiply this value by .92235 (taking 92.35 percent of it). IRS calls the result "net earnings from self-employment." If this amount is under \$400, no tax is owed at all. If the amount is \$94,200 or less (in 2006), the self employment tax is 15.3 percent of these "net earnings." If the net earnings exceed \$94,200, the first \$94,200 are taxed at 15.3 percent, the amount above this sum at 2.9 percent. For example, suppose a person had net earnings of exactly \$100,000. The tax would be \$14,413 on the first \$94,2000 (15.3 percent) and \$168 on the \$5,800 (2.9 percent) exceeding the base value, for a total tax of \$14,581.

Why this curious two-tiered calculation? The base rate of 15.3 percent is made up of two contributions. The first is the Social Security tax, 12.4 percent of income, but ordinarily paid at the rate of 6.2 percent by the employee, an amount matched by the employer. This 12.4 percent tax applies only to a base income, in 2006 to income up to a maximum of \$94,200 (the "contribution base."). The balance of the FICA contribution, 2.9 percent, is for Medicare, again paid at the rate of 1.45 percent by the employee and matched by the employer, but this rate is applied to all net earnings. The self-employed individual is both an employee and an employer rolled into one and thus is taxed at 12.4 percent for Social Security (up to the maximum level) and 2.9 percent for Medicare on all income.

The base income to which SECA tax applies has gradually increased over time. Thus in 1986 the maximum taxable income for Social Security purposes was \$42,000, in 1996 \$62,700, and in 2006 \$94,200. Since 1982 the rate is set by the Social Security Administration under the automatic adjustment provisions of the Social Security Act; thus new base income figures are announced late each year for the following year. In the periods 1937--1974 and 1979--1981 these levels were set by statute. As this entry was being prepared, the contribution base for the years 2007 and beyond had not yet been published. The Social Security contribution rate (6.2 percent or, doubled, 12.4 percent) was last increased in 1990; the Medicare contribution (1.45 percent, 2.9 percent doubled) was last increased in 1986.

Each individual must calculate his or her self-employment tax separately--even when filing a joint return with another self-employed person. For example, a wife and a husband may both operate sole proprietorships, the wife having earnings ("net earnings" in the IRA sense) of \$80,000 and the husband \$45,000. The total tax to be paid by the couple in 2006 would be \$12,240 for the wife and \$6,885 for the husband (each income times .153). The total tax would thus be \$19,125. If the law permitted these two incomes to be merged and treated as one--which it does not--the SECA tax would be lower. Of the combined earnings of \$125,000, only \$94,200 would be taxed at 15.3 percent and the remainder of \$30,800 at 2.9 percent, for a total tax of \$15,306. Joint filing in this case still produces benefits, but not benefits derivable from the rules that govern SECA.

When a person has income from an employer as well as from self-employment, however, the person may combine the two incomes for purposes of calculating SECA. An example is provided by Diane Weber writing for Medical Economics concerning a person who earned a salary of \$80,000 and self-employment income of \$30,000 in 2006, with a "contribution base," that year of \$94,200. The total income thus was \$110,000. In addition to deductions already made by the employer on the \$80,000 in salary, the person would be required to pay in addition 15.3 percent on \$14,200 of the \$30,000 (calculated by taking \$80,000 from \$94,200) and 2.9 percent on \$15,800 (calculated by deducting \$94,200 from total income of \$110,000).

The person who first sets off on his or her own usually experiences the self-employment tax as something of a shock. The political and business hype seem to promote the values and virtues of small business--but the first experience of being self-employed is paying higher tributes to the government than heretofore, almost as if government policy were designed to discourage enterprise. Legislators are, of course, both aware of this reaction and inclined to be helpful, but many other issues enter into the broader policy. Growing pressures on the Social Security system, and even greater pressures on the Medicare system, indicate that cuts for the self-employed are unlikely to pass soon. The self-employed person is thus likely to continue to have to pay the costs of independent operation--whether as an individual or as a sole proprietor. Once a business is incorporated, the self-employed person can become an employee of his or her company, and revert to paying half the FICA total. To be sure, the company now has to pay the matching amounts, but the matching amount, in any case, can be deducted from income. Meanwhile the two identities, employer and employee, are once more separated.

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## BIBLIOGRAPHY

Weber, Diane. "Employment Taxes on Mixed Earnings." Medical Economics. 17 February 2006.

U.S. Internal Revenue Service. "Self-employment Tax." Available from http://www.irs.gov/faqs/faq-kw167.html. Retrieved on 29 May 2006.

U.S. Internal Revenue Service. Schedule SE (Form 1040). 2005.

U.S. Social Security Administration. "Contribution and Benefit Base." 14 October 2005. Available from http://www.socialsecurity.gov/OACT/COLA/cbb.html#Series. Retrieved on 29 May 2006.