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ABSTRACT
Prior work (Smith and Smith, 2017a) demonstrated how the current application of tax laws undercharges for self-employment taxes. Additional work (Smith and Smith, 2018) extended that prior research to include taxpayers with both employee earnings and self-employment income. This paper adds a more specific analysis about the overstatement of income taxes resulting from the self-employment tax understatement.
Key Words: Self-Employment Tax, Self-Employment Income, Income Tax
INTRODUCTION
Smith and Smith (2017a) demonstrated how the current application of tax laws undercharges for self-employment taxes. However, that analysis presented only results of the self-employment tax deficiency for taxpayers who had self-employment income but no employee earnings. Smith and Smith (2018) extended their work to include taxpayers with both employee earnings and self-employment income. In addition, although they indicated that the understatement of self-employment taxes leads to an overstatement of income taxes, Smith and Smith (2017a) did not provide any specific analysis of the amount of this overstatement. This paper provides a more specific analysis about the overstatement of income taxes, which are a consequence of the understatement of self-employment taxes.
In most cases, the understatement of self-employment taxes and resulting overstatement of income taxes for individual taxpayers will be fairly small. However, taxpayers with larger amounts of self-employment income will face larger discrepancies. In either case, the macroeconomic impact on total taxes, both self-employment taxes and income taxes, could be significant.
The analysis and numbers presented in this paper use the 2017 maximum Social Security earnings base. They also use the 2017 income tax laws.
Because a major change in income tax laws was legislated at the end of 2017 (P.L. 115-97), the numbers provided here would be different for 2018. However, the concepts presented are still relevant even with the income tax law update.
BACKGROUND
Employees and employers each pay 6.2% for Social Security taxes and 1.45% for Medicare taxes (often called FICA taxes when combined) for the amounts paid in compensation. The Social Security tax has an annual maximum earnings base per employee on which it is levied each year, $127,200 for 2017. The Medicare tax has no annual maximum.
Those who are self-employed pay both parts of the tax, resulting in selfemployment tax rates of 12.4% for Social Security taxes and 2.9% for...