Final answer:
Individuals who are self-employed must pay both employee and employer portions of Social Security and Medicare taxes. Social Security tax for employees is considered regressive as high-income earners pay a smaller percentage of their income. Budgeting is crucial to manage expenses with after-tax income for personal finance planning.
Step-by-step explanation:
Self-Employment Taxes
When an individual is self-employed and their business is not incorporated, they are responsible for both the employee and employer portions of payroll taxes. This means that the self-employed individual must pay a Social Security tax (officially known as Old Age, Survivors, and Disability Insurance, or OASDI) and a Medicare tax.
The Social Security tax rate for self-employed individuals is 12.4% on net earnings up to a certain threshold ($127,200 for the year analyzed), and the Medicare tax rate is 2.9% on all net earnings.
In the context of the Social Security tax being set at 6.2% for employees below a certain income level, this tax is considered regressive because it takes a larger percentage of income from low-income earners compared to high-income earners.
It is because the tax rate doesn't increase with the amount of income past the threshold, which means a smaller fraction of total income is taxed for those with higher earnings.
Mary Ann's example helps illustrate the real-life implications of budgeting with after-tax income. She intends to save 10% of her after-tax income, but must subtract fixed and variable expenses such as rent, cell phone, and groceries to determine if this is possible.
It emphasizes the importance of understanding one's take-home pay and the impact of taxes and deductions on personal finance planning.