Self-Employment Tax vs Payroll Tax: How to Boost Tax Savings

Self-Employment Tax vs Payroll Tax: How to Boost Tax Savings
Anoosh Kotak26 January 2024

According to a survey by Fiverr, 66% of respondents plan to join a freelance platform for better flexibility, prevent job insecurity and gain financial freedom. 

The survey also reveals that the top three goals of freelancers in 2024 were earning, saving and investing. If you also have these goals and want to switch to full-time freelancing, you should consider several factors, especially tax benefits.

This blog helps you understand the difference between self-employment tax vs. payroll tax in the U.S. with tips on how to maximise tax savings as an employee or independent contractor.

Employee Tax Benefits

Here are some of the tax benefits that U.S. employees enjoy.

Employee Tax Benefits

1. Withholding Taxes

An employer deducts or withholds this amount from your salary and pays to the government on your behalf. It reduces your liability to calculate payable tax based on your salaried income.

Moreover, employees can seek government benefits such as social security income, unemployment insurance, disability insurance and medicare benefits with payroll tax deductions.

Withholding taxes also serves as income proof, making it easier to avail loans and clear other relevant applications.

2. Social Security and Medicare Contributions

All employees in the U.S. have to pay Social Security tax and Medicare tax. However, this tax isn’t paid directly to the government. 

Employers deduct these taxes from the wages and deposit them with the government on behalf of the employees as per the Federal Insurance Contributions Act (FICA). Therefore, it reduces the burden on employees. 

Moreover, the employers also make FICA contributions of 6.2% of each employee’s salary to Social Security tax and 1.45% to Medicare tax.

3. Health Insurance

U.S. employees also get access to health insurance with minimum essential coverage. Moreover, many employers offer other health insurance benefits such as disability cover, vision and dental support.

4. Tax Credits

Low-to-moderate-income employees can avail of the Earned Income Tax Credit (EITC). This tax benefit lowers the tax liability of individuals.

Some amount is credited to the taxpayer's account, depending upon their marital status and number of children. Therefore, the Earned Income Tax Credit maximises tax savings. You can check the eligibility, application requirements and credit limits here.

Additionally, during COVID-19, the U.S. government introduced the Employee Retention Tax Credit (ERTC) for employees working at organisations shut down during the pandemic.

5. Other Benefits

Full-time employees can avail the benefits provided under the Fair Labor Standards Act (FLSA). It offers fair standards for minimum wages, overtime, leaves and holidays, among others. However, it does not protect independent contractors’ rights.

For example, as an employee, you have fixed working hours, approximately 40 hours per month. If you must take up any work requiring long working hours, you will get adequate overtime compensation. However, as an independent contractor, there is no fixed standard for overtime if you spend extra hours on client projects.

Employees are also eligible for stock option schemes. Thus, employees get higher financial benefits as the company grows. However, Independent contractors do not inherit stock option schemes.

Some additional benefits available to employees include the following.

  • Paid maternity/paternity leaves
  • Paid vacation leaves
  • Commuting/travel allowances
  • Gym/wellness benefits 

Contractor Tax Benefits 

Some significant tax benefits available to independent contractors or self-employed individuals include the following.

Contractor Tax Benefits

1. Control Over Work and Finances

Work flexibility and significantly growing earnings are the two key benefits of working as an independent contractor. You can show several expenses as business expenses and seek deductions to reduce your taxable income.

Moreover, sole proprietorships can also avail of the Qualified Business Income (QBI) Deduction as per Section 199A. This scheme allows Independent contractors to reduce their QBI by up to 20%. However, there are several limitations to availing QBI according to business type and other factors.

Additionally, if the business expense of independent contractors is higher than their business income, they can deduct the net loss from their gross income.

2. Deductible Business Expenses

Independent contractors can show most of their expenses as business expenses and deduct them from the total income to maximise tax savings. Some of the standard business deductions you can claim in the U.S. are listed below.

  • Home office deduction, including rent, maintenance and repairs, mortgage interest and home depreciation
  • Business Insurance
  • Health insurance
  • Office expenses, including maintenance, utilities and supplies
  • Advertising expenses
  • Travel expenses
  • Internet bills
  • Vehicle expenses
  • Education Expenses

3. Healthcare Benefits 

The Affordable Care Act allows access to affordable healthcare benefits for independent contractors. You may also be eligible for tax credits if you purchase the insurance from the Health Insurance Marketplace.

4. Self-Employment Tax Considerations

Independent contractors or sole proprietors in the U.S. have to pay two types of taxes: the income tax and self-employment tax which comprises Social Security and Medicare taxes. 

While finalising their self-employment tax consideration, independent contractors can also deduct the amount which would have otherwise been paid by an employer and adjust the gross income accordingly.

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