Do You Pay Tax on Labor? Income, Sales & SE Tax Explained
Learn how income from work and services is taxed. Understand your tax responsibilities for various earning methods.
Labor, representing income earned from work or services provided, is subject to various forms of taxation in the United States. Different tax structures apply depending on whether one is an employee or an independent contractor. Consumers may also encounter taxes on certain services purchased. This overview aims to clarify the primary taxes associated with labor income and services.
Tax on Wages for Employees
When individuals work as employees, their wages are subject to several types of taxes. Federal income tax is a progressive system, meaning higher earners pay a larger percentage of their income.
Most states also levy an income tax on wages, though rates and rules vary. A few states, including Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming, do not impose a statewide income tax. Some cities or localities may also impose their own income taxes on employee wages.
Employees also contribute to Federal Insurance Contributions Act (FICA) taxes, which fund Social Security and Medicare. For Social Security, the tax rate is 6.2% of wages, applied up to an annual wage base limit of $176,100 for 2025. Employers match this 6.2% contribution, bringing the total Social Security tax to 12.4%.
Medicare tax is 1.45% of all covered earnings, with no wage base limit. Employers also match this 1.45%, for a combined 2.9% contribution to Medicare. An additional Medicare tax of 0.9% applies to individual wages exceeding $200,000, or $250,000 for married couples filing jointly, and $125,000 for those married filing separately. This additional tax is paid solely by the employee, with no employer match.
Tax on Income for Independent Contractors
Individuals working as independent contractors or who are self-employed also have tax obligations on their labor income, which differ from those of employees. This income is subject to federal income tax, but it typically does not involve immediate tax withholding by a payer. State income tax also applies to self-employment income in states that impose it.
The Self-Employment (SE) Tax covers both the employer and employee portions of Social Security and Medicare taxes. The self-employment tax rate is 15.3%, consisting of 12.4% for Social Security and 2.9% for Medicare. This rate is applied to 92.35% of the net earnings from self-employment.
Independent contractors are responsible for paying both halves of these contributions, unlike employees whose FICA taxes are split with their employer. Self-employed individuals can deduct one-half of their self-employment tax from their gross income. Independent contractors can also deduct ordinary and necessary business expenses incurred to generate their income.
Understanding Withholding and Estimated Taxes
The method by which individuals pay their income and payroll taxes throughout the year depends on their employment status. For employees, employers withhold federal income tax, state income tax, and FICA taxes directly from each paycheck. The amount of federal income tax withheld is guided by the information an employee provides on Form W-4. Employers then remit these withheld taxes to the government on the employee’s behalf.
Independent contractors, who do not have an employer to withhold taxes, are typically required to make quarterly estimated tax payments. These payments cover their federal income tax and self-employment tax obligations. The IRS provides Form 1040-ES. The purpose of estimated taxes is to ensure taxes are paid as income is earned, preventing a large tax bill or potential penalties at year-end for underpayment.
At the end of the tax year, employees receive Form W-2 from their employer. Independent contractors, conversely, receive Form 1099-NEC from clients who paid them $600 or more during the year.
Sales Tax on Services
Sales tax on services applies from the consumer’s perspective on certain purchased services. This tax is primarily a state and local matter, as the federal government does not impose a general sales tax on services. States and localities have varying rules regarding which services are subject to sales tax.
While many states do not tax most services, some specifically tax particular types of services. Examples include repair services, cleaning services, landscaping, telecommunications, and digital services. Some states also tax personal services, such as tanning or tattooing, or amusement and recreation services.
The consumer pays this sales tax to the service provider. The service provider is then responsible for collecting and remitting these taxes to the appropriate taxing authority. This sales tax on services is distinct from the income or payroll taxes paid by the individual performing the labor, as it is a tax on the transaction of purchasing the service itself.