Reducing the Self-employment tax

[jmjj215]

We've talked about incorporating as an S-corp to reduce the SE tax (if you pay yourself a 'reasonable' salary). I didn't incorporate last year but will definitely do that this year. Are there any other ways I can reduce the SE tax I'm going to have to pay? I'm not looking forward to it. I have the money, just no desire (strangely enough).

I recognize I need to lower my taxable income through deductions but I'm having a hard time finding them. My business is all online and has very little overhead. Help! The TAX MAN cometh!

[VJW]

Well, as a hint, there is no FICA obligation on commissions. But you realize they calculate your Social Security monthly benefit utilizing your highest 10 years of income ?

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[AntiCost]

How are you being paid right now? 1099? Do you pay taxes quarterly?

If you're not using an accountant; it may help to get one. It'll be a deductible expense as well..

[jmjj215]

Well, as a hint, there is no FICA obligation on commissions.

That's very interesting. I'll have to look into that.

Right now I'm paid directly by my customers and for all of 05 operated as a sole-proprietorship. I'm guessing the commission thing won't work because sole-proprietors have to pass through pretty much everything.

I don't pay taxes quarterly, but I did increase my withholdings from my "normal" job, which should have covered quarterlies (I hope).

I'm not too keen on getting an accountant. I've studied plenty of accounting and tax and feel comfortable doing the filing myself. I try and avoid all expenses, including deductible ones, unless I really need them (unless the deduction is depreciation, then I'm all over that).

[Optsol]

From the sound of it you'll be 1099-ed, so the commission thing is out the window.

Off topic, you should send *something* quarterly... anything -- else the IRS will assume you were ditching them. No idea what kind of money you're talking about, but you may be looking at a bit of a penalty this year. Regardless, it's an audit flag to not send them anything. If it's your first year, and if you did not 'owe' money on 15 APR last year, then you'll most likely avoid the penalty.

If you're doing the same thing for 2006, they will expect you to pay quarterlies based on what you earned that quarter. Expect means they'll bang you with penalty if you do not. And I would strongly recommend you put your withholdings back to normal on your W2 position. This way you pay as you earn with your side business, and you're not giving the gov't a free loan if things go slow.

Anyway -- I know the SE tax is tough to swallow... One thing you may consider next year is including the 14% into your base hourly rate. That way you don't have to have a ton of concern over it, since it's basically built into your income.

You may want to search around for the deduction piece as well.... have your clients ever contacted you on your cell phone? ding. New computer? ding. Upgrades? ding. Take them out to dinner? ding. internet connection? ding, % of your home used exclusively for your business activites? ding ding.

Anyway, it's all doable solo. g/l

[sweeps]

On-topic article here.

[Russell]

Originally Posted by Optsol

% of your home used exclusively for your business activites? ding ding.

I've heard many many times that this is the most common red flag for an audit.

[Russell]

Originally Posted by Sweepsplayer

On-topic article here.

I think they're talking about husband-wife unincorporated businesses or LLCs.

Jesse is a sole propreitor so I don't think he gets hit by the double SE taxes the article talks about.

[AntiCost]

There aren't many benefits (not worthwhile) to deducting a portion of your household for your business. Any money that you pay back to yourself (from the business) needs to be considered income on your personal return.

Plus, as someone else mentioned, it's one of those 'red flags'..

[kristinecfp]

Re: the home office deduction, yes it is something the IRS watches for, but if you have a designated home office (a space used ONLY for your business), then your expenses are legitimate and should be claimed as a deduction from your business income.

If you are an S corp, you would actually pay yourself a reasonable rent (based on your share of household expenses directly related to the home office) for the home office expenses incurred. The S corp would get the deduction for the rent paid to you, and you would report the rent as income on your personal tax return. This is beneficial to you because the rent is not subject to SE tax.

Another strategy that I don't recall being mentioned in this thread is reimbursing yourself for business use of your personal automobile. You have to drive to places like the post office, office supply store, etc. The mileage for trips made for business purposes is a legitimate deduction. You can reimburse yourself from the S Corp for the business miles driven or actual expenses if you want to keep all of your gas, repair, maintenance receipts.

Hope this helps!

[Russell]

What about using SEP IRA to put money towards your retirement and reduce your taxable income (not 100% sure if its after tax contributions or pre-tax contributions ) ? Doesn't it have a big contribution limit something like $14k or x% of your income ?

[kristinecfp]

A SEP IRA is a great way to reduce your income taxes if you're a small business owner; just realize it does not reduce SE tax. The maximum SEP IRA contribution is 20% of your net SE income if you're self-employed, 25% of wages if you're an employee, with a maximum cap of $42,000 for both.

[Russell]

Kristine, wouldn't it lower your SE taxes 'amount' since your taxable income is lower ? I understand that the SE taxes will stay 15.3% or whatever it is but it'll be 15.3% of a lower amount.

[kristinecfp]

No. SE tax is assessed on your business income; SEP IRA contributions reduce your taxable income, but not your business income. If you look at a tax return, you'll see that SEP IRA contributions are deducted on page 1 of Form 1040, instead of on Sch C (or instead of the business return if an S Corp or C Corp).

Even if you have an S Corp and the S Corp makes matching contributions for yourself (and any other employees), only the company match contribution would be deductible from business income, and you would be required to include that contribution on your W-2 as wages, which means you would still owe SE taxes.

I wish SEP contributions did reduce business income, but unfortunately that's not the case.

[jmjj215]

Man, if the SEP did, wouldn't that be a blessing.

For '06 I do plan on incorporating as an S-corp. I looked into having my wife as a shareholder as well, but I guess husband and wife count as one shareholder. My plan is to pay myself a reasonable salary and take the rest as profit distributions that are not SE-taxable.

I set up a SEP w/ Vanguard yesterday and will contribute the max 20% (they say 25%, but as kristine mentioned, if you're self-employed it works out to 20% because they do some funky calculations with the SE tax). At least that will lower my TI.

I'm a grad student, so I still get the Lifetime learning credit, and we didn't make a ton this year or anything. The SE income was substantial enough for me pull my hair out over the SE tax though

To the quarterlies. Once I'm incorporated as an S-corp, I will file quarterlies. Having it taken from the W2 instead of business money was perfectly okay for me last year - it's all a wash anyway. I do hope I'm not underwithheld enough to merit a penalty. '05 was the first year I had any TI from this business, so I think I'll be okay as far as any penalties go.

Kristine, would you mind explaining (or pointing me to an explanation) of how the SEP may work differently once we're incorporated? Could I technically take my personal income from the SE (let's say it was $4,000) and then have the Scorp match me up to the $42k, or is the employees + employer's contribution subject to the 25%/42k limit?

[kristinecfp]

The SEP contribution limit is based on your wages once you're incorporated. Here's an example of how it will work.

Your SCorp makes $100,000 profit, you decide to pay yourself wages of $60,000/yr, or $5000/mo. When you write your paycheck each month you will withhold your own SEP contribution, which can be up to 25% of your wages, or $1250/mo. Your SCorp will then match your SEP contribution, but only up to the company match designated in the plan when setup (usually 3% of wages). Your company match in this case would be $150/mo. In this example you would put $15,000 in your SEP for the year, with a company match of $1800.

I mentioned that you could put a maximum of $42,000 in a SEP IRA in an earlier post. You would need to have $168,000 of wages to be able to do that, since you can't contribute more than 25% of your wages to the SEP.

If you need more examples check out this article at Investopedia: http://www.investopedia.com/universi...ra/sepira2.asp

[jmjj215]

Does the plan have to be limited to 3%? If I'm the sole employee of the S-corp, could I set up the plan to match it 100%? I would contribute 25% of my wages, $1,250 / month, and the SEP, from it's profits would contribute another $1,250 per month?

I think I'll go read that article

[jmjj215]

From what I read, it looks like the SCorp can make the contribution on behalf of the Employee, up to 25% of the employee's wages, or $42k. Can the employee also make contributions (with their wages) up to 25%? Or has the Scorp maxed out the total contribution allowed?

[kristinecfp]

Actually, you've got it backwards. The employee of the S Corp can elect to defer up to 25% of their salary, the company itself can only match the amount indicated in the plan (when setup). Companies can choose to match 1-3% of employee contributions, or they can do a 2% non-elective contribution (all employees would get the 2% regardless of whether they contribute to a SEP or not).

Fidelity and Vanguard both have good info on SEP IRAs on their websites if you want to research further.

[jmjj215]

Ah, so in reality I'm looking at 25% of my wages from the scorp + 3% of that 25% as my maximum deductible contribution. The 3 percent would be deductible from the scorp, and the 25% would be a for-AGI deduction on my 1040 as an employee..

Thanks for all the info!