Key Takeaways
- You're responsible for paying self-employment taxes, which fund Social Security and Medicare.
- You can deduct between 50% and about 57% of your self-employment tax payments to adjust your income.
- Forming an S Corporation can reduce your self-employment tax liability by allowing you to pay yourself a reasonable salary and distribute the remaining profits to yourself, which aren't subject to employment taxes.
- Be thorough in preparing your Schedule C to ensure you deduct every possible business expense, which must be ordinary, necessary, and not personal.
Additional taxes for the self-employed
There are many advantages to self-employment in comparison to being employed by someone else, like being able to set your own hours and not having to punch in every morning. But, at the end of the day, your tax obligations are similar to those of employees.
Aside from the income tax, you'll need to pay self-employment taxes that support the Medicare and Social Security programs. These tax obligations can be daunting, but there are some ways the self-employed can reduce the amount they owe.
Self-employment taxes explained
Self-employment taxes exist solely to fund the Social Security and Medicare programs. Employees pay similar taxes through employer withholding, and employers must make additional tax contributions on behalf of each employee. The self-employed are required to pay all of these taxes themselves.
SE tax deduction
The Internal Revenue Service requires anyone making $400 or more in self-employment income to file a tax return. The return must include a Schedule SE, which you use to calculate how much self-employment tax you owe.
However, when you are filling out your 1040, the IRS allows you to deduct a portion of the self-employment tax payments you make as an adjustment to income. You can deduct between 50 and approximately 57% of your self-employment tax payments. The precise amount depends on how much self-employment income you earn.
TurboTax Tip:
By lowering your net profit through deductions, you'll save money on your self-employment tax bill.
S Corp savings
If you create a corporation or limited liability company, making an S Corp election with the IRS might present some opportunities to reduce your self-employment tax liability. With an S Corp, you generally pay yourself a reasonable salary out of earnings. You can distribute any remaining profits to yourself and any other shareholders or partners or leave the money in the business. In certain situations, money in excess of your salary is subject to income taxes but not employment taxes.
For example, if you operate your business as a Sole proprietorship and you earn $100,000 for the year, self-employment tax is due on the entire amount. However, under the appropriate circumstances with an S Corp, the amount that exceeds the reasonable salary you make isn't subject to self-employment taxes.
Reducing net profit
Schedule C calculates your net profit from self-employment. You must include this as income on your 1040 and use it on Schedule SE to calculate your self-employment tax. Your net profit is equal to the gross receipts you earned minus your deductible business expenses. The lower your net profit number is, the lower your self-employment tax bill will be.
Therefore, to reduce your self-employment tax, you should be extremely thorough when preparing your Schedule C to help ensure you deduct every possible business expense. Your business expenses need to be ordinary and necessary to operate your business to be deductible. They can't be personal in nature. Common types of deductible business expenses include:
- office rent
- the cost of acquiring and maintaining a business vehicle
- telephone calls
- office supplies
- equipment
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