If you are self-employed you are no stranger to taxes. The three most common taxes for the self-employed are self-employment tax, federal income tax, and state income tax. Self-employment tax is 15.3% for the first $106,800 of earned income and 3.9% for all earned income above $106,800. It is a significant tax that should be considered in tax planning. Self-employment tax is assessed to a particular type of income called earned income or compensation income. Unearned income is not subject to self-employment tax. The individual facts and circumstances of your case will determine your strategy for minimizing your total tax liability, not just your self-employment tax. A basic understanding of what having earned income and paying self-employment tax entitles you to is necessary. The main benefit of having income subject to self-employment tax is becoming eligible for social security benefits. Social Security Administration requires you have a certain number of quarters as one of the criteria for eligibility for social security benefits and disability benefits. Individuals can earn up to four quarters per year by having at least $4,200 in self-employment income. The Conservation and Energy Act of 2008 set some major changes to the optional methods of computing self-employment tax. These changes specifically effect farmers and self-employed taxpayers whose self-employment income is less than $4,200 or even a loss.
There are two optional methods for self-employed individuals to choose from. In essence what this election does is qualify the taxpayer for up to four credits of Social Security benefit coverage for each tax year. The taxpayer would otherwise not qualify for lack of enough earned income. Let us take a look at two different approaches, one for taxpayers seeking to minimize their self-employment tax and one for those looking to maximize their total tax savings.
For example, one taxpayers' case may indicate a need to minimize his/her self-employment tax. Some tax planning strategies to convert earned compensation income or earned income into unearned income are as follows:
|Earned Income Credit||$4,590|
|Self Employment Tax||-$244|