June 4, 2015
Tax for Self Employed – How can I reduce my Self Employment Tax Chicago Illinois?
Self Employment Tax is one of the major issues that we deal with in Business Tax Preparation. The problem is that it is so expensive in lower and middle income brackets. Self employment tax is basically both sides of social security and medicare tax combined. Whether you are a sole proprietor or a partner in a partnership, you have probably discovered just how expensive this tax on the self employed can be.
Why are self-employment taxes so expensive?
Let’s illustrate this with an example. You are filling a Married Filing Joint Return as a sole proprietor. After all of your deductions on the Schedule C, you are left with $100,000 in taxable income. You do not itemize or have any other deductions or credits. Your total income tax on the 2014 return is $9,986 while the self-employment tax is another $14,130. If you are a partner in a general partnership, an LLC, or an LLP, your taxation costs are not the same but very similar.
Why is the self employment tax more expensive than the income tax? Because SE Tax is a flat percentage rather than a graduated tax with brackets and deductions. First, the couple is not paying income tax on the entire $100,000 because they get a credit for half of the self employment tax as well as the standard deduction and two exemptions. They are only paying income tax on $72,635. The income tax rate starts at 10% and goes up 15%. Tax for Self Employed is a flat tax with no standard deductions or exemptions. This is why it can be more expensive.
In many instances, this can create a a tax problem that over years can ultimately put a person out of business.
What can be done to solve this problem?
Changing the taxation status of your entity may do the trick. I didn’t say that you had to change the entity. Your legal status does not necessarily dictate how you file your taxes. You can be an LLC from a legal standpoint that is taxed as an S-Corp. Why would you consider being an S-Corp? There are no self-employment taxes on S-Corp Income. Certainly you would need to take a salary that was reasonable and pay Social Security and Medicare taxes on your W-2. But in most instances, that W-2 might be much less than the entire income of the business, therefore saving you substantial amounts of self employment tax.
Tax Planning for Small Businesses
Your Small Business Accountant needs to have these conversations with you. Saving clients money on their taxes does not just happen. It is a matter of planning and knowledge. In many instances, saving clients money on their taxes is what allows them to stay in business in the first place.
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