Final answer:
Self-employed taxpayers pay self-employment taxes on their net profit, which are double the rate of traditional employees' payroll taxes because they cover both the employee and employer shares for Social Security and Medicare. The Medicare tax is proportional, whereas the Social Security tax is proportional up to a wage limit and regressive above that limit. Payroll taxes are a significant part of federal revenue, emphasizing the importance for self-employed individuals to properly manage their tax responsibilities.
Step-by-step explanation:
Self-employed taxpayers are required to pay self-employment taxes on their net profit, which combines both the employee and employer components of the Federal Insurance Contributions Act (FICA) and Medicare taxes. Unlike traditional employees, who see 6.2% of their paychecks deducted for Social Security and another 1.45% for Medicare, self-employed individuals must cover the full 15.3%—twice the amount, since they are effectively both the employee and the employer. However, it is important to note that even traditionally employed workers may indirectly pay the employer's share through lower wages, as economists suggest that businesses adjust compensation to account for their tax expenses.
With the rise of the gig economy, many workers are receiving income reported on Form 1099, classifying them as independent contractors. This expands the responsibility of managing taxes to the individual, requiring that they not only pay income tax but also handle their payroll tax obligations themselves. Pertaining to progressive, regressive, or proportional tax forms, the Medicare payroll tax is known as a proportional tax, being a flat percentage of all wages earned, while Social Security tax is proportional up to a certain wage limit—above this limit, it becomes a regressive tax, as higher-income earners pay a smaller fraction of their income compared to lower earners, despite the 6.2% rate applying only up to an income ceiling.
The significance of payroll taxes is underlined by the fact that they, along with individual income taxes, make up more than 80% of federal revenue. Understanding the structure of these taxes is crucial for the self-employed to comply with tax regulations effectively and to plan their finances accordingly.