Self-employment tax is a tax that is paid by self-employed individuals on their net earnings. This tax is made up of 12.4% for Social Security and 2.9% for Medicare. As a self-employed individual, you are responsible for paying both the employer and employee portions of these taxes, which can add up to 15.3% of your net earnings.
There are a few strategies that self-employed individuals can use to minimize or avoid self-employment tax.
Incorporate your business as an S corporation
As an S corporation owner, you will pay yourself a reasonable salary, which is subject to Social Security and Medicare taxes, but you will not be required to pay self-employment tax on the remaining profits. Instead, these profits will be taxed as regular income, which is typically subject to a lower tax rate than self-employment tax.
Take advantage of tax deductions
As a self-employed individual, you are entitled to a variety of tax deductions that can help reduce your taxable income and lower your self-employment tax bill. Some common deductions for self-employed individuals include home office expenses, travel expenses, business supplies, and health insurance premiums. Be sure to keep careful records of all your business expenses so you can take advantage of every possible deduction.
Contribute to a retirement plan
Contributing to a retirement plan is another effective way to reduce your self-employment tax bill. When you contribute to a traditional IRA, SEP IRA, or 401(k) plan, you can deduct your contributions from your taxable income, which can lower your overall tax bill. Additionally, you will not have to pay self-employment tax on the money you contribute to your retirement plan.
Hire your children
If you have children who are under the age of 18, you can hire them to work for your business and pay them a reasonable wage. This will allow you to deduct their wages as a business expense and reduce your taxable income. Additionally, your children can contribute to their own IRAs and other retirement plans, which can help them build a nest egg for the future.
Use a Health Savings Account (HSA)
A Health Savings Account (HSA) is a tax-advantaged account that allows you to save money for medical expenses. If you have a high-deductible health plan, you can contribute to an HSA and deduct your contributions from your taxable income. Additionally, your contributions to an HSA are not subject to self-employment tax.
Consider a partnership or LLC
If you have a business partner, you may want to consider forming a partnership or limited liability company (LLC). When you form a partnership or LLC, you will split the profits and pay self-employment tax only on your share of the earnings. This can be a good option if you and your partner have different levels of income or if you want to limit your personal liability for business debts.
Self-employment tax can be a significant burden on your income, but there are several strategies to reduce or avoid it. From structuring your business as an S corporation to taking advantage of deductions and credits, you have several options to consider. However, navigating the complex tax code can be challenging, especially if you are a business owner with multiple responsibilities. That's where our tax experts at Accountants Now can help. We have a team of experienced accountants who can guide you through the tax planning process and help you minimize your tax liability. Contact us today to schedule a consultation and learn more about how we can support your financial goals.