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How to Reduce Self Employment Taxes

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Self-employment covers all activities you engage in to earn money by providing services as an independent contractor, through a business you operate as a sole proprietor or because of your interest in a partnership that carries on a trade or business. As a result, you’ll need to calculate your self-employment tax obligations each year, but there are some tips you should be aware of that may reduce the amount you have to pay.

What is Self-Employment Tax

Self-employment taxes are funds collected by the federal government that are used solely to fund Social Security and Medicare. These taxes are separate, and in addition to your obligation to pay income taxes. Employees pay the same taxes through employer withholding, though employers pay half of the tax on behalf of their employees. Since self-employed taxpayers don’t have an employer to make these matching tax payments, they are required to pay all tax themselves.

Deducting SE Taxes

Each year that you earn $400 or more of self-employment income, the Internal Revenue Service will require you to file a tax return, which must include a Schedule SE. Schedule SE uses the net profit you compute on your Schedule C as the amount on which self-employment taxes are calculated. However, the IRS does allow the self-employed to deduct half of the SE tax payments they make on their 1040 as an adjustment to income.

S Corps & SE Tax

If you incorporate or form an LLC for your self-employment activities, making an S corp election with the IRS on Form 2553 can provide opportunities to significantly reduce the amount of self-employment taxes you pay. With S corporations, you can allocate some of your earnings as wages that are subject to self-employment tax, with excess profits only subject to the income tax. For example, if you’re a sole proprietor and earn $200,000 of net profit, you will owe SE tax on $200,000. However, if you have a corporation or LLC that makes an S corporation election on Form 2553, you can pay yourself a reasonable salary of $75,000 and thereby reduce the amount of earnings subject to self-employment tax from $200,000 to $75,000.

Schedule C

The Schedule C separately calculates your net income from self-employment activities, which you must include on Form 1040 and on Schedule SE. Net income is simply the gross revenue you earn less all business expenses you can deduct. The lower your net income is, the less you will owe in self-employment taxes. Therefore, evaluating all possible deduction you can take on Schedule C is incredibly important since it affects your self-employment tax bill – not just your income tax bill. To be deductible, your expenses must be ordinary and necessary for operating your business, meaning they aren’t personal in nature. Deductible business expenses commonly include rent, the cost of acquiring and operating cars and trucks, cell phones, office supplies and computer equipment.

Reference:
Self-Employment Tax (Social Security and Medicare Taxes)