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If you're a small business owner, time, capital and resources are precious commodities. We
can help you with 2 major obstacles — retirement planning and self-employment
taxes — so you can spend time on what's important to you: running your business.
Self-employment Tax - How Are You Affected?
You are faced with a tax situation that is unique to you — self-employment tax (SE tax).
It can be difficult to understand what it is and why it seems you may have to pay additional
taxes because you are self-employed. By having a basic understanding of what you face, you
and your H&R Block financial advisor can address the financial, tax and investment
implications, so you can manage a successful business.
Paying Both Halves of Social Security & Medicare Tax
As an employee, half of Social Security tax and half of Medicare tax is paid by
an individual via payroll withholding. The employer is responsible for paying in the
employee's share on his or her behalf, as well as the employer's half of these taxes.
As a self-employed individual, you are required to pay both halves — the entire amount
of Social Security and Medicare taxes. Even though you are responsible for full payment of
these, you will receive a small break allowed by the tax law. You can reduce your earnings
from self-employment by the employer's share of the taxes before applying the SE tax
percentages: 100%-7.65% = 92.35%.
Will You Pay More Tax as a Self-employed Person?
The following comparison of 2 taxpayers illustrates how the self-employed individual
fares in comparison to an employee of a business.
Henry is a self-employed salesman. For 2004, he has gross income of $75,000 and $10,000 of
business expenses. Harriett has a full-time sales position at a company and earns $75,000
in salary and commissions. She has $10,000 in un-reimbursed employee business expenses. Both
are single, have itemized deductions of $13,800 (other than Harriett's business expenses),
and have no other income. The chart shows the total tax that Henry and Harriett will pay in
2005.
As shown, Harriett pays $5,738 ($75,000 7.65%) in Social Security and Medicare taxes.
We know that Henry has to pay both "halves" of these taxes. Yet, his total tax, although
higher, is not $5,738 higher than Harriett's. Why?
- Harriett's social security/Medicare tax is calculated on her gross income of $75,000. Henry's SE tax is calculated on his earnings from self-employment (i.e. after deducting expenses) and is further adjusted as explained above. His calculation: ($65,000 * 92.35% * 15.3%) = $9,184.
- Henry is able to deduct 100% of his expenses and half of his SE tax, so his income subject to income tax is lower.
- Harriett must reduce her employee business expense deduction by 2% of adjusted gross income (AGI). Her deductible employee business expense is therefore only $8,500 ($10,000 - ($75,000 * 2%)). Henry is able to deduct his $10,000 business expenses in full.
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Strategies for Reducing Your Tax Bill
Deductions are a key way to reduce your taxable income and thus reduce your tax bill. As a business owner, you are eligible to take half of your SE tax as an above-the-line deduction on your tax return, which helps to put you more on a par with employees. If you qualify, these above-the-line deductions can be claimed in addition to the standard or itemized deductions.
Above-the-line deductions for all taxpayers include:
- Student loan interest — up to $2,500
- Tuition and fees deduction — up to $4,000 of qualified higher-education expenses
- Moving expenses — the cost of moving your family and belongings to a new job location
- Alimony paid
- Military reservists deduction — a brand-new deduction for non-reimbursable travel expenses for reservists who service more than 100 miles from home and stay overnight
Additional deductions for self-employed individuals include:
- Half of self-employment (Social Security and Medicare) tax
- 100% of self-employed health insurance premiums for you and your family
- Contributions to self-employed retirement plans, such as SEPs, SIMPLEs, and defined contribution plans
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Additional Deductions Claimed on Schedule C
In addition to the above-the-line deductions, you also have some deductions that are claimed
directly on your Schedule C. These include:
- Advertising and promotional costs
- Business liability insurance
- Legal and professional services
- Car and truck expenses
- Wages, employment taxes, employee benefit plans and contributions to employee retirement plans
- Home office expenses
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Experience the H&R Block Difference
Your financial advisor and an H&R Block tax professional can work together to make sure you
are taking advantage of all the tax benefits and retirement planning options available to
small business owners. Talk to your H&R Block financial advisor or call our Investor Center
at 866-295-7912 to get started today.
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