There are numerous tax benefits of owning a business. However, self-employment taxes are not one of them. Self-employment taxes are a huge burden to small business owners that regular employees don’t have to deal with.
In this article we will show you what self-employment taxes are and how you can minimize them.
What are Self Employment Taxes?
The IRS requires anyone with self-employment income to file self-employment (SE) taxes. Self-Employment taxes are 15.3% of your net earnings. Your net earnings are your income minus any business expenses. Typically, employees pay half of this tax and employers pay the other half. But since you are both the employee and the employer, the IRS requires you to pay both halves.
The following people need to pay self-employment taxes:
- Freelancers
- Independent contractors
- Sole Proprietorships
- LLC Owners
How to Calculate Self-Employment Taxes
2022 Tax Rates
The 15.3% self-employment tax is comprised of the following:
- Social Security: 12.4%
- Only the first $147,000 is subject to the Social Security Tax
- Medicare: 2.9%
- All earnings are subject to the Medicare Tax
- An additional .9% tax is levied on self-employment earnings above $200K
Calculation
The self-employment tax can be complicated for someone not trained in the IRS tax code. Always consult with a CPA to make sure you’re compliant with all laws and regulations.
How to Calculate Self-Employment Tax:
- Start with business income minus business expenses to get net earnings
- Multiply net earnings by 92.35%
- Multiply that number by 15.3%
How to File Self-Employment Taxes
Your self-employment taxes are filed with your individual tax return.
- Fill out and attach Schedule SE
- Report calculated self-employment taxes on Schedule 2
- Report one half of SE tax on Schedule 1
- Include all income, tax, and deductions on Form 1040
Four Strategies to Lower Self-Employment Tax
1. Form an S-corp
The best strategy to lower your self-employment taxes is to form an S-corporation. With an S-corporation you can pay yourself part of your income as a “reasonable salary”. Only this salary will be subject to the self-employment tax. Although there is no rule defining a “reasonable salary,” the general rule is to not pay yourself less than 50% of net income. You cannot take advantage of this strategy with a sole proprietorship or a regular LLC.
Here is an example to understand this tax benefit better:
Let’s say you own an LLC that made $60k in profit this year. Unfortunately this means you will have to pay about $9,180 in self-employment taxes.
Now let’s say you own an S-corp that made $60k in profit this year, and you also paid yourself a salary of $30K. This means only $30k is subject to the self-employment tax, so you will only pay $4,590 in self employment taxes.
So in this example, an S-Corp would save $4,590 in self-employment taxes for the year. Now go invest that money back in your business.
2. Take All of Your Deductions
A lot of small business owners tend to be scared to take all of the business deductions they are entitled to due to a fear of an IRS audit. But do not worry. You are not required to pay a penny more in taxes than necessary.
Below is a list of common deductions I don’t see business owners taking advantage of:
- Home Office Deduction
- Vehicle Deduction
- Depreciation
- Continuing Education
3. Contribute to a SEP IRA
Contributing to a SEP IRA is a great tax planning strategy to lower your immediate tax liability and grow your future wealth. The amount of money you contribute to your SEP IRA, directly lowers your income subject to taxes.
In 2022, you are allowed to contribute up to 25% of your self-employment income to a SEP IRA. The amount you can contribute is capped at $61,000 per year. You can deduct contributions if your business is reporting a loss on your tax return.
4. Contribute to a Health Savings Account (HSA)
Similar to the SEP IRA strategy, contributing to a Health Savings Account (HSA) is a great way to lower your tax liability and plan for the future. An HSA is only available to you if you are on a high-deductible insurance plan. However, this is an amazing strategy if you and your family are relatively healthy.
In 2022, the maximum HSA contribution limits are $3,650 for individuals and $7,300 for families. All money contributed to an HSA is deducted from your taxable income. This money stays in a bank or investment account until you need to pay qualifying medical expenses. Additionally, you are allowed to withdraw the money the same way as an IRA.
Conclusion
The self-employment tax can come as a shock to a lot of small business owners. However you can minimize your self-employment taxes by creating an s-corporation, recording all deductions, and contributing to an IRA and HSA.
Tax planning is most effective when done early. Click the button below so we can implement these tax strategies for you and save your hard-earned money!
