How to Avoid Self-Employment Tax & Ways to Reduce It (411 × 600 px)

How to Avoid Self-Employment Tax & Ways to Reduce It

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Throughout its history, America has been the land of self-made men and women. But, America’s self-employed must contend with a unique burden every April 15 (this past year, April 18): the self-employment tax. In addition to federal, state, and local income taxes, simply being self-employed subjects one to a separate 15.3% tax covering Social Security and Medicare. While W-2 employees “split” this rate with their employers, the IRS views an entrepreneur as both the employee and the employer. Thus, the higher tax rate.

The following six tips will help ensure that you do not pay a cent more in self-employment tax than the law requires and keep as much as you can of your hard-earned money.

Form an S Corporation

The self-employment tax applies only to what the IRS calls “earned income” – that is, money paid to you as a salary or wage. There may be reasons to consider forming an S corp to save money, but they need to consider other factors like having to form a board which they don’t have to do under an LLC. It does not, however, apply to dividends (or “unearned income.”) The way to receive business income in the form of dividends is to create an S corporation. Nothing changes except that your clients or customers now pay the corporation instead of you directly. Instead, you begin withdrawing a salary from the corporation – but not a full salary. By paying 60% to yourself in the form of salary and 40% in the form of dividends, you will exempt that 40% from self-employment taxes.

As MyMoneyBlog explains in its comprehensive breakdown of the S corp strategy, “the difference between $90k salary vs. $50k salary/$40k dividends is $6,000 a year” in tax savings!

Young Black business woman doing calculations.

Subtract Half of Your FICA Taxes From Federal Income Taxes

Entrepreneurs are also eligible to deduct half of their self-employment taxes from their federally taxable income. Using the above example: let’s say you owe $7,650 in self-employment tax, which is 15.3% of the $50,000 salary your S corporation paid out. You can now, in turn, deduct $3,825 (which is half of $7,650) from your federally taxable income of $50,000. This way, the IRS can only tax $46,175 of your salary instead of the entire $50,000. While it does not reduce your self-employment tax, it reduces the total amount of tax you pay by lowering your taxable income.

Deduct Valid Business Expenses

The IRS allows business owners and entrepreneurs to deduct all “ordinary and necessary” business expenses. Here, “ordinary and necessary” is the operative phrase. You cannot take a trip to Hawaii and write it off, for instance, unless you genuinely went there to work. You can, however, deduct anything used to generate your income: office space, supplies, advertising costs, business travel, even a prorated portion of your mortgage and utilities (if you maintain a home office.) Therefore, if you rack up, say, $10,000 in business-related expenses during the year, you can reduce your taxable income from $50,000 to $40,000. Your self-employment tax obligation will now be 15.3% of $40,000 (which is your net income) rather than $50,000 (which is your gross.)

Deduct Health Insurance Costs

One substantial tax advantage the self-employed have over employees is the ability to deduct health insurance costs. As The Balance explains, you can “deduct 100% of health insurance premiums you pay for yourself and your qualifying dependents” so long as you had a net profit for the year. Like the business expenses above, deducting your applicable health insurance costs reduces your taxable income for that year, thereby reducing the total dollar amount of taxes paid.

Close-up of a man holding a tablet reviewing a health insurance policy.

Defer Income to Avoid Higher Tax Brackets

Another creative but perfectly legal way to reduce your self-employment taxes is to defer income. As a self-employed person, you can choose whether to get paid now or later. While it might seem foolish to delay receiving income, consider the following scenario. Let’s say that even after taking every legally permissible deduction, you are still on pace to have received $45,000 in net income during the 2023 tax year. By arranging to be paid even $276 of that in January 2024 rather than now or before the end of the year, your 2023 income will be taxed only at the 10% and 12% income tax rates. None of it will be taxed at the 22% rate, as would any amount of salary between $44,726 – $95,375. 

TurboTax has helpfully published the marginal income tax brackets for 2023 here. Be mindful of them and consider whether it might objectively make sense to defer some of your income. If you don’t need it right away, deferring income is an excellent way to reduce both your income taxes and self-employment taxes.

15 responses to “How to Avoid Self-Employment Tax & Ways to Reduce It”

  1. Question – What if you are both self-employed and a W2 employee (i.e. I have a career job with healthcare benefits but also have a Sole Prop consulting gig on the side). Can I deduct the cost of the healthcare expenses that I pay out of my W2 to reduce my 1099 income (I hope I’m saying this correctly)? No need to get separate healthcare if I get it through my W2 – but it’s an expense I pay never-the-less. I’m guess not possible, but never hurts to make sure 😉 Ty!

    • Hi Paul,

      No, the Healthcare expenses from the W-2 would be deducted as an Itemized deduction on schedule A.

      A Supplemental Health or Dental policy that is outside of the W-2 withholding is acceptable as an expense to being Self Employed.

      TurboTax asks you simple questions about you and gives you the tax deductions and credits your eligible for based on your answers.

      Thank you

  2. This article contains a glaring omission that should have at least been mentioned in the “Defer Your Income” section: you can defer your self-employment income by contributing to a solo 401(k), a SEP-IRA or a SIMPLE IRA. That’s often the #1 strategy.

    • James, from my understanding using a 401k will only defer income taxes, not self-employment taxes. That is likely the reason it wasn’t discussed in the article.

  3. Thank you for this information. I am not sure where on Turbo tax to Subtract Half of Your FICA Taxes From Federal Income Taxes. Please help. Also aside from health care premiums can you deduct any other health care costs co-pays ext.?

  4. Some of what is told about here, about the Federal United States Self-Employment tax’s terms, has changed as of 2012:

    1. SE tax is now 13.3 %, 2 % lower than before. 15.3 % was the rate for at least the last decade, but it is now lowered.

    2. You can deduct more than half (see the 1040SE form for details) of your self-employment taxes, from your taxable income… provided your taxable income or your self-employment income is below a certain level. (See tax forms, either the 1040 instructions or the 1040SE form, for details.)

    I have not yet found out who is responsible for these rather merciful changes, but I would like to know.

  5. Whilst trawling through the internet I found this blog. After I finished reading this I entertained about some of the values mentioned here and it definitely gave me many views on the different things refered to within this blog.

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