Contractor License Practice Exam

Which of the following is true about self-employment tax?

1. It is the same as employment tax

2. It applies only to corporate employees

3. It covers both Social Security and Medicare taxes

4. It is optional for business owners

The correct answer is: It covers both Social Security and Medicare taxes

The statement that self-employment tax covers both Social Security and Medicare taxes is accurate. Self-employment tax is specifically designed for individuals who work for themselves, and it includes contributions that fund these two essential federal programs. Unlike traditional employment where the employer shares the load of Social Security and Medicare taxes, self-employed individuals are responsible for the full amount, which combines both the employee and employer portions into a single rate. This tax is calculated based on net earnings from self-employment, and it ensures that self-employed individuals contribute to their future Social Security benefits, just as wage earners do through payroll taxes. Understanding this is crucial, as failing to calculate and pay self-employment tax correctly can lead to underpayment penalties and affect future benefits. In contrast, the other options do not capture the essence of self-employment tax accurately. For example, self-employment tax is not the same as employment tax in general, as the latter refers more broadly to taxes levied on workers' wages and includes various taxes other than just Social Security and Medicare. It also does not apply solely to corporate employees; in fact, it primarily impacts individual contractors and freelancers. Finally, self-employment tax is not optional for business owners; it is a legal requirement for those earning