While being an entrepreneur allows for great freedom in your work schedule, location, and creative vision, paying self-employment taxes can be daunting. Because you are essentially paying the taxes required from the employer and the employee, the total combined federal, state, and self-employment tax bracket may be as high as 37% in some states. However, with careful planning, you can lower your self-employment tax liability and maximize your profits.
Tip #1: Think About Registering as an S-Corp
Setting up an S-Corp may reduce your taxes by allowing you to pay yourself as an employee of your company and also receive shareholder distributions. While you do have to pay Social Security and Medicare taxes out of your employee salary, these are not taken out of your distribution payments.
To determine if an S-Corp is right for you, do some market research for the mean salary for someone in your position. If your business is significantly more profitable than the average base-salary for your role, registering as an S-Corp is definitely worth exploring.
However, you should also be conscious of the fact that an S-Corp requires more maintenance, including holding shareholder meetings, incorporating bylaws, taking minutes of meetings, and distributing stock.
Tip #2 Find Ways to Lower Your Reported Profit
Self-employment taxes are calculated from your reported net profit (Your earnings – business expenses.) Making sure you maximize your allowable deductions is the most important factor in lowering your tax liability. Taking deductions for travelling expenses, meals with clients, equipment, and administrative costs such as cell phone, internet, and web hosting will reduce the amount of income on which you will be taxed. Be careful that you are only deducting expenses truly related to the business. For information on home office deductions, you can read our blog here.
Tip #3 Deduct Health Insurance Costs
While this technically falls under tip #2, so many people miss this deduction that we thought it deserved its own tip. If you are not receiving health coverage through your spouse, you can (and should) deduct your health insurance costs. Since these expenses can be comparatively high for entrepreneurs, this can significantly lower your tax liability.
Tip #4 Raise Your Prices to Reflect Your Tax Liability
While this may seem obvious, many business owners think about their rates in terms of their overhead costs and time investment but may not think to factor in the taxes that they will need to pay. To calculate your estimated taxes, determine your tax bracket, add self-employment taxes, and factor the final number into your pricing strategy.
Tip #5 Defer Income to Avoid Higher Tax Brackets
If you’ve determined that you’re on the cusp between two tax brackets, you may want to defer income until the next calendar year if possible. Income is taxed based on the year in which it was received (if filing on a cash basis), so if the last few months of the year roll around and your income is at the top of the range for your current tax bracket, deferring income to January may be beneficial.
While self-employment taxes can be frustrating, they don’t have to be a barrier to running your own profitable business! By using the strategies above, you can lower your self-employment taxes and save more money towards the things that matter to your business and your family.
The details shared in this post were taken from information written by Matt Baker who is VP or Corporate Strategy and International Expansion with Freshbooks and shared on the accountingWEB blog.