How to Reduce Self Employment Tax

Most businesses today operate as a sole proprietorship.

In recent years, many have structured themselves as LLCs, seeking a legal shield to protect their personal assets (home, investments, etc) from the risks of owning a business in today’s lawsuit-happy society.

But these choices leave you exposed–and I mean WIDE OPEN exposure–to self-employment tax. Which is basically just another term describing the Social Security and Medicare taxes you have to pay when you own your own business and no one is deducting taxes from your compensation.

Consider changing your tax status to that of an S Corporation. It’s not hard to do, and the tax savings can be absolutely HUGE.

Created under Subchapter S of Chapter 1 of the Internal Revenue Code of the United States, S corporations are a separate legal person from the owner/employee. An S corporation can pay you in two ways; (1.) as an employee, and (2.) as the owner.

As I tell my tax clients, you wear two hats as the owner/employee of an S Corp. When you wear your employee hat, and do the work of the business, you are paid ‘reasonable compensation’, as would any other employee doing the same work. The corporation in this case is liable for payroll taxes –Social Security and Medicare included– on each dollar you are paid as a corporate employee.

But you also wear an investor hat, and any profit earned by the business over and above your employee wages is not subject to payroll taxes. So you save 15.3% of tax on these dollars, which can save you thousands of dollars each year.

Any way you look at it, a tax dollar saved is way more than a dollar earned!

Posted in Small Business.

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