If you are self employed and filing your tax return using Schedule C, there is a good chance you are paying more self employment taxes than you need to.
Self employment taxes are a combination of Social Security and Medicare taxes. The ocial Security portion is 12.4% of your net earnings from self employment up to an annual ceiling amount. The Medicare portion is 2.9% of your net earnings from self employment with no ceiling.
If you were ever an employee, your employer paid half of these taxes for you, usually 7.65%. If you are self employed though, you are responsible for paying both halves.
One way to help reduce your self employment tax liability is to form an S-Corp. With an S-Corp, you become both the employer and the employee. You determine (with our assistance) a reasonable salary to pay yourself as an employee. A reasonable salary will often be much less than your net profits from self employment would be. Since the Social Security and Medicare taxes are only paid on the salary piece of your income (not your total profits), you are able to reduce your total tax liability.
Not quite making sense? Here is a quick example.....
You are currently self employed and after all expenses will have net income of $75,000. If you were to pay an employee to do your work (not the administrative piece, just the work you charge for), you may pay them $36,000 a year.
Here are just the self employment related taxes you would pay if you continue to use Schedule C.
Net Profit $75,000
Net Earnings from Self Employment $69,263
Total Self Employment Tax $10,597
Here are the employment related taxes and fees you would pay if using an S-Corp
Salary subject to payroll taxes $36,000
Payroll taxes 5,800
S-Corp tax return fees 850
Payroll prep fees 900
Total Payroll Taxes & Fees $7,550
So in this example, you end up reducing your self employment tax (even after our fees) by almost $3,050. Note that we did not factor in the self employment tax deduction you would normally get because the value of this deduction will vary based on your total income from all sources as well as the Indiana county you live in.