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Tips to Reduce Self-Employment Taxes

  Sanjiv Gupta CPA  Published 
Tips to Reduce Self-Employment Taxes

Tips to Reduce Self-Employment Taxes

Self-employed individuals must know that aside from income tax, they must pay self-employment taxes that support Social Security and Medicare programs. There are ways that can reduce the amount that they owe.

More and more individuals opt for self-employment as opposed to being employed because they can set their own hours and are not pressured to punch in a fixed schedule each morning. However, when the day ends, they still have similar tax obligations as full-time employees. Aside from the income tax that they have to pay, they must secure payment for self-employment taxes such as Medicare and Social Security. The fact that they have their own businesses definitely increases the exertion of record-keeping that must be done for tax purposes. Whenever the self-employed digs through countless boxes of business receipts, they envy those who are just required to enter their over-all income from their W2 form.

Self-employment is synonymous with freedom. It is also synonymous with responsibility and therefore, lots of expenses. There are self-employed individuals who choose this path because they prefer the first two, but they cringe every time it is tax time. This is because they are not completely aware of some of the tax write-offs that they are actually entitled to.

It may seem daunting at first but there are various ways that allow the self-employed individual to reduce the amount owed.

Educational Expenses

When it is time to file income tax returns, self-employed individuals must not hesitate to take claim of their benefits simply because they are their own boss. For example, an expense that they can get paid for is “educational expense.” This is a deduction that is often overlooked. If the self-employed are taking courses or even buying material that is needed for research, then this is considered a deductible because it makes one’s work more effective.

Individual Retirement Plans (IRAs)

The best tax write-off for those who are self-employed is their retirement plan. This is because they have no employees that they are required to set individual 401k plans for. However, for those who are self-employed and have employees, it is recommended that they opt for SIMPLE or what is also known as the Savings Incentive Match Plan for Employees IRA. This is an IRA-based plan that provides small employers with a method that is simplified and easy to understand so that they can also contribute to the retirement of their employees.

Therefore, retirement plans are the best kind of tax deduction. To top this off, the government even assists in funding this.

Self-employment taxes 101

Self-employment taxes are up and about so that the programs from Social Security as well as Medicare are funded. Employees must pay similar taxes by going through what is known as employer withholding. Employers make additional tax contributions and they do this for their full-time employees. Self-employed individuals must pay all these taxes on their own.

Tax Deduction for SE

The IRS or the Internal Revenue Service requires those who make $400 or above this amount in being self-employed to file a tax return. The return must have a Schedule SE. This is used to calculate how much taxes that the self-employed individual owes. However, when the 1040s are being filled out, the IRS lets the self-employed deduct a percentage of their tax payments and also adjust to their income. They can also deduct around 50 to 57% of the self-employed tax payments. The exact amount depends primarily on how much the self-employed can earn.

S Corp Savings

 If the self-employed create a business as a corporation or an LLC (Limited Liability Company), then making the S Corp election with IRS can present opportunities that also reduce their self-employment tax liability. With S-Corp,  individuals pay a reasonable salary from their earnings. They can also distribute the profits that remain to themselves as well as the other shareholders and even the partners and leave the remaining in the business. There are situations that the money is in excess of the salary that is calculated for the income tax but is not exempted from the employment taxes.

For example, if the self-employed operate the business and lists this as a sole-proprietorship then they earn $100,000 for that given year. Self-employment taxes are then due on that amount. However, there are also appropriate circumstances along with the S Corp that the amount may also exceed the salary that is reasonable for the self-employed to not be subject to self-employment taxes.

Reducing Net Profit

The Schedule C-EZ or popularly known as Schedule C calculates the net profit of the self-employed individual. They must then include and list this as an income on their 1040. They can use this on Schedule SE so that self-employment taxes can be calculated. The net profit is also equal to the gross recipients that the individual earned after business expenses have been deducted. This lowers the net profit number. The lower the amount is, then the lower the employment tax bill is.

In order to reduce self-employment taxes, the individual must also be extremely accurate and thorough when filing and preparing the Schedule C. This ensures that the deductions are possible. The business expenses must be necessary in order to operate the business as a deductible. This cannot be filed as personal in nature. There are various types of deductible business expenses. These are the cost of acquiring as well as maintaining a business vehicle, office rent, calls made and office equipment and supplies.

Using the home or dwelling for business

Most self-employed individuals start their businesses as home-based businesses. Therefore, they must determine which business costs are deductible. They should always keep track of the expenses that are related to their housing costs because their houses are the locations for their business.

If the taxpayer’s gross income from the business exceeds the total expenses, then they can deduct all the expenses that are related to their business use in their home. If the gross income is less than the total expenses, then the deduction is also limited to the difference of the gross income and the sum of every business expense that the individual would pay if the business is not conducted in the home. These expenses also include the Internet, phone lines and other costs that the business accumulates.

The individual must have a home office that is exclusively used for the business. This is because the Internal Revenue Service requires self-employed individuals to document this.

Deducting Automobile Expenses

If the individual travels for the business, even if it is short distances in the city, this must be deducted and documented as business miles traveled on the tax return. The taxpayer can also file the over-all actual expenses that have been incurred and use the standard mileage rate that is prescribed by the IRS. The IRS also has a mileage rate that is allowed and should be checked each year that they can change.

If the taxpayer decides to use the actual and over-all care expenses, they have to include depreciation, insurance, registration, payments, licenses, maintenance, repairs, garage rent, fees for parking and too. If taxpayers decide to use the standard mileage rate, it would be best that they keep a log. Document daily, weekly and monthly usage of miles and also distinguish the business use from personal use.

Depreciation of equipment

There are some people who are self-employed and can purchase the equipment and property for the business. If they expect that the property will last longer than a year, it could also be depreciated on the tax return. According to the IRS, claims regarding the property must meet these criteria: the taxpayer must own the property and it must be held and used to generate income. The property must have a useful life, meaning the individual can guess how long the owner can generate income from it. It may not be considered a useful life if it is just a year or less and it can also not be disposed of and purchased in the very year.

There are certain repairs on the property that has been used for the business that can also be deducted. Another advantage is that it facilitates the system that lets the individual track the changes conducted every year.

Other areas to explore

There are deductions that can be missed especially in advertising as well as promotional expenses, air, bus and train fare, and banking fees. Restaurant meals along with other entertainment costs are also easily written off as long as these are necessary and important business expenses.

In addition, self-employed individuals are suggested to consider health insurance premiums that represent credit and not a tax deduction. This is because the credit directly goes against the taxes and not a reduction of the income.

No matter which expenses that the taxpayer discovers can be written off, the important thing to remember is that records must be accurate throughout the year. Save the receipts, as well as email receipts and log and file these so that it is easy to retrieve them during tax time.

Long-term tax-saving strategies

Individuals are encouraged to not look at the last-minute write-offs especially when considering the tax deductions from being self-employed. They should think about laying long-term strategies connected to saving money, especially in an annual context. This is highly suggested if the taxpayer earns a lot.

Accountants are trained to tell their clients what they have to pay. They are not working to come up with strategies for payment reduction.

To reduce the gross taxable income, taxpayers are also asked to consider setting up a benefit pension plan that is well defined. The basis of this plan is age and income. The older the individual is and the higher his earnings, the more they are allowed to contribute. Another alternative plan is an age-weighed profit-sharing plan. This is similar and beneficial to entrepreneurs that hire several employees.

Another strategy for business owners who earn higher than average has their own building through LLCs or limited liability companies. A similar business structure is required to pay rent. This rent is then used to pay the mortgage. However, this is also regarded as a business expense strictly for tax purposes.

Self-employed professionals are required to have liability insurance and they should consider setting up their very own insurance company. A captive insurance company insures the risks that any businesses can accumulate. The premiums are also tax-deductible.

However, they are warned that if the money has been accumulated along with claims that are minimal, then the money is taken out and filed as taxable under capital gains. This is actually not a retirement strategy, but it saves them money and lets them pay this by themselves instead of getting an insurance company to deduct this as premiums. With these long-term strategies that end up complicated, financial planners and business attorneys must be consulted in order to ensure that the best plan possible is made for the business to thrive.

Being self-employed also means taking on costs and risks that are not encountered when they are employed by someone else. They are responsible for obtaining customers and generating income. They also have to constantly prove the value of the service and the product. They also have to pay the internet bills and phone bills that are incurred to get and also retain these customers. Other costs include travel expenses for meetings and above all, liability insurance just in case they are sued.

Numerous tax codes have been written in order to soften the blow of covering tax costs. Everyone must claim the business tax deduction that they qualify for. The profitability of the business depends on minimizing the costs as well as maximizing the resources. There are small business tax deductions that are regarded as more complicated. Remember that any time that the cost is an expense that is legitimate, then the IRS will eventually examine this and see if it can be audited.