Self-Employed Contributions Act

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21 Aug, 2024

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Self-Employed Contributions Act (SECA) is a US tax law, which mandates self-employed individuals to deduct an employer-equivalent amount as tax, which is later used to support Social Security and Medicare benefits, ensuring financial security and healthcare for retirees and the disabled.

It works similarly to the Federal Insurance Contributions Act (FICA) taxes and guarantees fair contributions, securing future benefits like retirement and disability support. SECA taxation ensures consistent funding for these vital programs, promoting equity and stability in fiscal matters for both self-employed individuals and society.

Self-Employed Contributions Act (SECA) Definition

Self-Employment Contributions Act (SECA) is a tax law requiring self-employed individuals to pay Social Security and Medicare taxes on their earnings to fund Medicare and Social Security programs.
It provides stability in the fiscal environment for both self-employed workers and society as a whole.
Federal Insurance Contributions Act (FICA) and the Self-Employment Contributions Act (SECA) differ primarily in taxpayer responsibility and tax rate. FICA splits the tax burden between employees and employers at a rate of 7.65% each, while SECA imposes the full 15.3% tax on self-employed individuals, covering both employer and employee shares.

Self-Employed Contributions Act Explained

Self-Employment Contributions Act (SECA) of 1954 is a significant tax law in the United States that pertains to small business owners, including those operating as S corporations, partnerships, and sole proprietorships. It mandates these individuals to pay a tax of 15.3% on their net income from self-employment. This tax covers their contributions to Social Security, Medicare, and Old Age Survivors and Disability Insurance (OASDI) costs. These are crucial for ensuring financial security and healthcare benefits for retirees, the disabled, and their dependents.

SECA distinguishes self-employed individuals from those employed by companies or other entities. While employees only have to pay half of the Social Security and Medicare taxes, with the other half withheld from their paychecks by their employers, self-employed individuals are responsible for both portions. This requirement ensures equitable contributions to these essential social welfare programs. This is because self-employed individuals are both employers and employees of their businesses.

The calculation of SECA taxes is based on the net earnings from self-employment. This is determined after deducting the costs associated with the business activity. The tax rates for Social Security and Medicare components are applied to different income thresholds. Adjustments are made periodically by the Social Security Administration. Despite the tax burden faced by self-employed individuals, the SECA tax system aims to maintain the sustainability of Social Security and Medicare programs, which serve as critical pillars of support for millions of people across the United States.

History

The Self-Employment Contributions Act (SECA) was enacted in 1954 to establish a tax on the self-employment income of individuals. Section 1401 of the Internal Revenue Code imposes this tax, defining self-employment income as the net earnings derived by an individual from self-employment, with specific limitations.

Over time, the base income subject to SECA tax has seen gradual increases. For instance, in 1986, the maximum taxable income for Social Security purposes was $42,000, which increased to $62,700 in 1996 and further to $94,200 in 2006. Since 1982, adjustments to the rate have been made by the Social Security Administration under the automatic adjustment provisions of the Social Security Act, with new base income figures announced annually for the following year. While from 1937 to 1974 and 1979 to 1981, these levels were set by statute.

As of the preparation of this entry, the contribution base for the years beyond 2007 had not yet been published. The Social Security contribution rate, last increased in 1990, stands at 6.2% (doubling to 12.4%), while the Medicare contribution, last increased in 1986, sits at 1.45% (doubling to 2.9%).

The Internal Revenue Service contends that limited partners in these partnerships should be subject to SECA taxes on their annual allocations of partnership earnings, contrary to the long-standing interpretation under the LP Exception. The LP Exception traditionally exempts limited partners' distributive shares from SECA taxes, but the proliferation of new entity types has complicated enforcement.

Two pending cases, including Soroban Capital Partners LP v. Commissioner and Sirius Solutions, LLLP v. Commissioner, provide clarity on the application of the LP Exception to different partnership structures. These cases challenge the IRS's interpretation and advocate for a strict application of the LP Exception.

Examples

Let us look at the instances to understand the concept better -

Example #1

Assuming an individual grosses $80,000 from self-employment activities and incurs $20,000 in ordinary and necessary business expenses, their net earnings would be calculated as follows:

After deducting business expenses, their net income amounts to $60,000. Next, let us calculate the net earnings from self-employment by multiplying $60,000 by 92.35%, which is equal to $55,410.

Then, applying the SECA tax rate of 15.3%:

$55,410 multiplied by 15.3% equals $8,477.13.

Therefore, based on these calculations, the individual would owe $8,477.13 in self-employment taxes for the year.

Example #2

Consider Sarah, a freelance graphic designer. She earns $70,000 annually from her design projects. Unlike traditional employees, Sarah doesn't have taxes withheld from her paychecks. Instead, she's responsible for paying both the employer and employee portions of Social Security and Medicare taxes, totaling 15.3%.

While Sarah enjoys the flexibility of self-employment, she must budget accordingly to cover her tax obligations. Throughout the year, she sets aside a portion of her income to ensure she can fulfill her tax responsibilities come tax season.

Despite the additional tax burden, Sarah appreciates the benefits of being self-employed, such as setting her schedule and choosing her clients. However, she understands the importance of contributing to Social Security and Medicare to secure her future retirement and healthcare needs.

SECA vs FICA

Self-employed Contributions Act (SECA) and the Federal Insurance Contributions Act (FICA) are the two laws introduced by the US government. Though these seem to have similar features, the two differ widely. Let us check the differences between the two below:

FICA	SECA
Under FICA, non-clergy employees and their employers share the responsibility of paying the taxes, with each paying half of the total due.	In contrast, under SECA, self-employed individuals, including clergy, are responsible for paying the entire tax themselves, as they are considered both the employer and the employee.
The tax rate also differs between SECA and FICA. For FICA, the total tax rate is 15.3%, with each party (employee and employer) contributing 7.65% of the earnings.	However, under SECA, self-employed individuals are subject to the full 15.3% tax rate, as they are responsible for both the employer and employee portions of the tax.
FICA applies to non-clergy employees, including those working for private companies, government agencies, and certain nonprofit organizations.	On the other hand, SECA applies to self-employed individuals, including sole proprietors, partners in partnerships, and clergy members.

Frequently Asked Questions (FAQs)

What is the purpose of SECA?

SECA (Self-Employment Contributions Act) ensures equitable social security and medicare funding by requiring self-employed individuals to pay both employer and employee portions of the tax. This fosters financial stability and secures access to vital benefits for self-employed workers.

Do I need to pay the SECA tax?

If your net self-employment earnings in 2021 amounted to $400 or above, and your total income from other employment doesn't exceed $142,800, or if you earned $108.28 in church-employee income, you're likely subject to SECA tax. However, if your self-employment earnings are below $400 for the year, you typically won't owe SECA tax. The SECA tax rates remain unchanged for self-employment income in 2022, but the wage threshold has increased to $147,000.

How much is the SECA tax?

The total SECA tax rate in 2024 is 15.3%, divided into:
12.4% for Social Security (capped at the first $165,200 of net earnings) and 2.9% for Medicare (no cap).To estimate potential tax liability, multiply capped earnings by 12.4% and add 2.9% of total earnings.