Whether working in the private sector, a government agency or a not-for-profit organization, most wage-earning employees will have 50% of Social Security and health insurance (Medicare) totals paid by their current employers. Self-employed individuals do not enjoy this same luxury and are instead required to pay the entire amount of these totals themselves. For this reason, understanding the health insurance taxation calculation is critical for business owners. To assist with filing convenience, both Medicare and Social Security are often grouped into a single calculation category. However, the two entities are not the same. Government regulations mandate they must be computed individually when net earnings surpass the Social Security contribution cap which was set at $106,800 in 2009.
Step By Step Calculation
To begin the process, a self-employed individual should determine overall net profit. Net profit is established by tallying the annual revenue and subtracting all deductible business operating costs. Line 12 on Form 1040 will also assist in verifying this number.
Next, consult Form 1040, Schedule SE to compute net earnings. Essentially, this number results from multiplying net profit by 0.9235. This final total is what self-employed individuals should use to gauge health insurance taxation.
Individuals with total net earnings of equal to or greater than $400 are required to pay self-employment taxes. These responsibilities include both Medicare and health insurance levies. Medicare, unlike social security, does not utilize any cap for excessive net earnings. Instead the Medicare tax is placed on the entire net earnings total.
To determine Medicare tax responsibility, multiply net earnings by 2.9%. The result will yield the Medicare health insurance tax owed. As a reference, to determine net earnings from an overall net profit of $50,000, a self-employed individual will multiply $50,000 by 0.9235 and obtain the result of $46,175. Taking that $46,175 times 2.9% yields a Medicare health insurance tax of just over $1339.
It's important to note that not all individuals with outside employment have these two important expenses covered. For example, many churches and other religious affiliations or organizations do not contribute any part of the Social Security or Medicare tax for their staff. Instead, employees of these associations should consult with Schedule SE. Although not technically a self-employed entity, they are obligated to determine the Medicare and Social Security tax requirement utilizing a separate equation.
Self-employed individuals often enjoy freedom and flexibility not offered to many employees working for outside entities. Understanding the legalities of health and social security taxation is an important piece of being one's own boss.
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