Taxation

In 1935, Congress enacted the Social Security Act to provide old-age benefits. The plan created the Old-Age, Survivors, and Disability Insurance (OASDI) to assist workers and their families and Medicare, a health insurance plan for people over 65. These benefits, in addition to other programs to aid those in need, were to be financed through a payroll tax. Employers make automatic deductions, or withholdings, from an employee's wages for Social Security and Medicare taxes. However, the withholdings account for only one-half of the taxes due and employers are required to match the employee's contribution. The employer is responsible for making the payment of Social Security and Medicare taxes to the U.S. Treasury. While there is a maximum amount of wages that are subject to Social Security taxes, all wages are subject to Medicare tax. The amount of the taxes and the benefits for Social Security and Medicare are adjusted frequently to keep pace with inflation. In addition to Social Security and Medicare withholdings, employers may also be responsible for making automatic payroll deductions for federal, state, and municipal taxes.

Sole proprietors, or people who work for themselves, are subject to a self-employment tax, which is composed of a Social Security tax and a Medicare tax. The self-employment tax is separate from the federal income tax and is based on net earnings from business operations. The tax is calculated by subtracting business-related expenses from gross income. Allowable deductions include expenditures such as rent, insurance, depreciation of property, and business and travel entertainment. However, many of these expenses are deductible subject to certain limitations. A self-employed individual may also have to make estimated quarterly tax payments for both federal and state taxes.