6 Self-Employment Tax Savings Ideas for Small Business

There have been a lot of temporary and proposed tax changes targeted toward small business.  Of all these changes and proposals the Self Employment (SE) tax changes are some of the more helpful.  Here's some background and ideas to help you reduce your SE tax.

Of all the taxes the dreaded SE tax is the tax that small business owners struggle with the most.  It is a 15.3% tax on the net profits of a small business that operates as a sole proprietorship or single-member LLC.  You may know it better as the Social Security and Medicare payroll tax that employers and non-owner employees split the cost of. 

Recently there were a few temporary rule changes to reduce the SE tax for small business.  There are other ways to minimize it as well.  First for the temporary rule changes:

1.  For 2010 only, self-employed persons are able to deduct their health insurance premiums as  a business expense that reduces their self-employment tax.  There is an existing adjustment to self-employed individuals taxable income for health insurance premiums.  In 2010 an additional deduction from SE taxable income is also available.

2.  Starting in 2011 a partial payroll tax holiday is in effect for those who pay self employment tax.  The employee share of the Social Security Tax has been reduced from 6.2% to 4.2% in 2011.  Keeping in line with this change the full SE Tax has also been reduced 2% from 15.3% to 13.3%.

Other tax moves to reduce the SE Tax (and income tax!):

3.  For sole proprietorship or single member LLC who have a spouse who help in the business hire the spouse and set up a Section 105 Medical Expense Reimbursement Plan.  The Section 105 plan covers uninsured medical costs for the employee-spouse, their spouse and dependent children.  The reimbursements of uninsured medical cost and health insurance premiums are deductions to the company for income and self-employment tax purposes which makes it better than say a Health Savings Account deduction which is only good for an income tax deduction.

4.  Make sure you are claiming every business expense deduction that you are entitled to.  Every dollar spent for business supplies, phone, auto, etc. will save on SE and income tax.  Spend some time with your accountant reviewing all allowable business deductions available for your business.

5.  If your sole proprietorship or single member LLC is generating a lot of income consider converting from a sole proprietorship or single member LLC to S Corporation status.  As an S Corp one can take a reasonable salary which is subject to "SE"  (Social Security and Medicare) Tax and distribute the rest of the company income as dividends free of "SE" tax.

6.  Make a qualified home equity debt interest election to treat interest expense incurred on home equity loans used entirely to finance your business as not secured by your qualified residence.  By making this election one moves the interest expense on their tax return from an itemized deduction on Schedule A to a business expense on say Schedule C.  The advantage of this is that one not only receives a deduction from taxable income but also a deduction for SE Tax purposes.

Contact me should you have any questions regarding this posting or other tax benefits of operating your own business.  Thanks for your time.
Andrew Jordan, CPA

The information provided is not intended as a substitute for legal or other professional services. Legal or other expert assistance should be sought before making any decision that may affect your situation.