THE BLOG
01/02/2013 03:31 pm ET | Updated Mar 04, 2013

Self-Employed Pay Highest Tax Rate in US

In many of his Rich Dad Poor Dad books, Robert Kiyosaki mocks self-employment as a choice that makes sole proprietors even poorer than employees. He's right, but not for the reason he thinks.

Robert Kiyosaki's dad's story

Robert Kiyosaki grew up with a highly-educated father who was a successful employee. His dad was an educator who rose to become Superintendent of Schools in Hawaii. But when laid off in middle age, Kiyosaki's dad opened an ice cream stand in Hawaii. He quickly went bankrupt.

Robert and his father ("poor dad") were both ashamed of his father's failure to earn a living as a sole proprietor of a business. In his first book, Rich Dad Poor Dad, Robert tells how he abandoned his dad's values of education and hard work and became an entrepreneur.

Kiyosaki's friend's "rich dad" taught Robert the secrets of how to make passive income, the kind of income wealthy people can live on if they choose not to work.

My dad's story

My dad dropped out of school in eighth grade after his father died of cancer. In the coal town in mid-Pennsylvania where he lived, boys were paid to throw logs under carts to slow down coal coming out of the mines. His classmate held onto a log too long and lost his arm. My dad refused to work in the mines.

To support his mother and sister he became a delivery boy in a dental supply company. While working, he got his GED; he met my mother and married. They had their first son and took a train up to Erie Pennsylvania. There my dad opened his own dental supply company, Northwestern Dental.

Starting a business on a shoestring

My dad was smart and street-smart. He invented a unique method to add long columns of large numbers in his head. To start a business during the Great Depression he literally dumpster-dived behind dentists' offices for catalogs. Each time a dentist bought supplies from a catalog, my father would buy two of each item and store the extras at home.

Eventually he needed an office for those supplies. He recruited a partner from General Electric to take care of the office while he made sales calls in Ohio, Pennsylvania, and New York.

There were some tough times, but his business lasted until he died at age 63. He had a house, a new car every year, clothes, food, vacations, and cash. He complained he hadn't become a millionaire. But when he died, the business was valued at half a million dollars, not a paltry sum in 1976.

What explains the difference?

Robert Kiyosaki claims his dad was over-educated. I disagree. Robert's dad failed because he went into business too late. My dad started his small business in a Horatio Alger time and place where it was possible to live well as a self-employed person. What changed?

In 1951 the IRS created the Self Employment (SE) tax to fund Social Security and later on, Medicare. SE tax rates rose steadily over 25 years from 2.25 percent to 7.90 percent in 1976, the year my dad died.

My dad started his business in 1933. He had 18 years to grow his business before SE taxes began in 1951. Ralph H. Kiyosaki started his ice-cream business in the 1960s, a decade after SE tax was implemented. Since my dad's death in 1976, SE tax nearly doubled to 15.3 percent.

Who pays the highest tax rate?

SE tax is similar to the part of payroll tax called FICA, but employees pay only half for their Social Security and Medicare taxes. Their employer pays the other half.

Self-employed pay twice what employees pay for Social Security and Medicare taxes.

Make no mistake - SE and FICA taxes are taxes on workers' income. The payroll tax increase of 2% for SE tax for 2013 means that all sole proprietors will pay 15.3 percent tax on "net business earnings" between $400 and $110,000. The exact same amount of income goes at the top of Form 1040. There it is taxed again as "gross personal income" at a progressive rate between 10 and 28 percent.

SE plus gross personal income taxes on the self-employed will total 25.3 to 43.3 percent for 2013.

Employees will pay 7.515 for FICA tax in addition to 10 to 28 percent for income tax on earnings up to $110,000. They'll pay a total rate of 17.515 to 35.515 percent for FICA plus personal income taxes.

The highest rate for self-employed, 43.3 percent, is also more than the top rate of 35 percent on American corporations, that on average, actually pay 12 percent on corporate income.

43.3 percent is even more than the top rate of 43 percent for billionaires' dividend income proposed for 2013!

Self-employed and employees with earnings over $110,000 pay no Social Security tax; just 2.9 percent for Medicare. Thus, it isn't true that 98 percent of Americans are getting tax breaks in 2013. Only workers making between $110,001 and $400,000 will get a break. And for workers making $110,000 or less, the highest income tax rate, 25.3 to 43.3 percent, falls on the self-employed.

SE tax is why self-employed wind up paying the steepest tax rate in America - on the lowest amount of income! SE tax is why millions of small businesses are failing. Clearly this won't help to end our Great Recession.