If you’re self-employed, you qualify for certain tax deductions as a result of paying for Medicare. When you are self-employed, you pay a “Self Employment Tax” on the net income that you earn from your own business, consisting of both the Social Security tax and the Medicare tax. The total of the two taxes is 15.3%, with 12.4% applying to the Social Security tax, while the remaining 2.9% is the Medicare tax.
For 2016, the Social Security tax is required to be paid on the first $118,500 of net income from your business. The Medicare tax is required to be paid on all of your net income from your business, even beyond $118,500. For example, if your business earns $200,000, you will pay the self-employment tax at a combined rate of 15.3% on the first $118,500 that you earn. The Medicare tax would continue to be paid on the remaining $81,500 of income. Luckily, you don’t have to do the math: TurboTax Self-Employed will handle all these calculations for you!
Medicare Tax Deduction #1: Your Income is Reduced by Half the Self-employment Tax – Before the Tax is Calculated
The 15.3% paid for the self employment tax, actually represents both halves of the FICA tax: the Federal Insurance Contributions Act, which helps to fund Social Security and Medicare. Salaried employees pay 7.65% of the tax, while their employer matches 7.65%, for a total of 15.3%. Since there is no employer when you’re self-employed, you must pay both halves of tax. That’s where the 15.3% comes from.
Because you pay the self employment tax in addition to regular federal income taxes, the IRS does provide fairly generous deductions for that tax. Those deductions mostly help to reduce your federal income tax liability, by lowering the amount of income that is subject to both taxes. The IRS allows you to deduct half of the self employment tax, which includes Medicare tax, before actually calculating the tax.
The IRS recognizes the extra burden of the self-employed in paying the employer half of the tax. For that reason, they allow you to deduct 7.65% of your net business income before calculating the self-employment tax.
Medicare Tax Deduction #2: Actual Medicare Payments Are Also Tax Deductible
The self-employed have one more potential tax deduction from Medicare that salaried employees don’t. The self-employed can use Medicare premiums paid to reduce their taxable income for federal income tax purposes.
The self-employed are permitted to deduct health insurance premiums as an “above the line” deduction. This not only means that Medicare premiums can be used to reduce taxable income, but the deduction can be taken even if you don’t itemize tax deductions on your return.
It also eliminates the medical expense reduction requirement when you itemize, in which you must first reduce your medical expenses by 10% of your just gross income (7.5% if you are 65 or older), that renders medical expenses non-deductible for some taxpayers.
Let’s say that a self-employed individual pays $1,500 in Medicare premiums during the year; he or she can deduct that amount from taxable income – even without itemizing expenses. Once again, if your marginal tax rate is 25%, that results in tax savings of $375. If you add up all the deductions that come from the self-employment tax – including the Medicare portion – you can save thousands of dollars in federal income tax.
Don’t worry about knowing how to calculate and deduct self-employment taxes. Don’t forget: TurboTax Self-Employed will ask you simple questions about you and your business and give you the tax deductions and credits you deserve based on your answers saving you money for your business.