Tax Advice

Everything You Need to Know About How to Lower Self-Employment Taxes in the U.S.

If you’re self-employed, understanding how to lower your self-employment tax can save you significant money. Many self-employed individuals pay more in taxes than necessary simply because they’re unaware of the strategies and tax deductions available to them.

Self-employment taxes can be one of the biggest challenges for small business owners, independent contractors, and freelancers. Unlike traditional employees, who split their Social Security and Medicare taxes with their employers, self-employed people are responsible for paying both the employer and employee portions of these taxes. This adds up to a self-employment tax rate of 15.3% on your net earnings, in addition to your income taxes.

The good news? You don’t have to let self-employment taxes eat into your hard-earned income. By leveraging deductible business expenses, taking advantage of the self-employment tax deduction, and exploring strategies like forming an S Corporation, you can significantly reduce your taxable income and self-employment tax liability.

In this guide, we’ll cover practical ways to lower your self-employment taxes. From claiming the home office deduction to deducting health insurance premiums and qualified business income, we’ll break down key strategies to help you keep more of your net business income. Remember, every situation is unique, so consult a tax professional to ensure you’re making the best decisions for your financial future.

Let’s explore how self-employed individuals can reduce their tax burden, improve their tax preparation, and make the most of tax season!

What Are Self-Employment Taxes—and Who Has to Pay Them?

Before diving into strategies to lower your self-employment taxes, it’s important to understand what they are and who is required to pay them.

Self-employment taxes are how self-employed individuals—such as sole proprietors, partners in a partnership, and members of certain limited liability companies (LLCs)—contribute to Social Security and Medicare taxes. These taxes are also referred to as payroll taxes, and if they seem higher than what employees pay, that’s because they are. Traditional employers split these costs with their employees, but self-employed people are responsible for covering both the employer and employee portions.

The current self-employment tax rate is 15.3% of net earnings, which includes 12.4% for Social Security and 2.9% for Medicare tax. This tax is in addition to federal and state income taxes owed on taxable income.

If your self-employment income is $400 or more in a tax year, you are required to pay self-employment taxes. This also applies to side hustles or freelance work generating more than $400 annually. To calculate your tax liability, you’ll need to file a Schedule SE (Self-Employment Tax) along with your personal tax return.

Certain thresholds and rules apply to higher earners. For example:

• Net earnings above $200,000 for single filers (or $250,000 for married couples filing jointly) are subject to an additional 0.9% Medicare tax.
• You can claim a self-employment tax deduction, allowing you to deduct half of your self-employment taxes when calculating your adjusted gross income (AGI).

Understanding how self-employment taxes work is the first step toward reducing your self-employment tax liability. From utilizing deductible business expenses to exploring tax benefits like the qualified business income deduction, there are numerous strategies to minimize your tax burden.

Now that you know who needs to pay self-employment taxes, let’s explore actionable steps to help you lower them and keep more of your net business income in your pocket.

7 Ways to Lower Your Self-Employment Tax

As a self-employed individual, managing your self-employment tax liability can be challenging, but there are plenty of strategies to help reduce the burden. Here are seven effective ways to lower your self-employment taxes, ensuring more of your business income stays in your pocket.

1. Maximize Your Deductible Business Expenses

Increasing your business expenses might sound counterintuitive, but it’s one of the most effective ways to reduce your self-employment tax. Since these taxes are based on your net earnings, the more deductible business expenses you claim, the lower your taxable business income will be.

Eligible business expenses may include:

• Office supplies deduction (e.g., furniture, computers, and software).
• Startup costs deduction, including costs to set up your business.
• Continuing education deduction (e.g., courses and certifications).
• Advertising and business credit card fees.
• Business insurance premiums.

Be sure to keep meticulous records of all actual expenses and receipts. Tools like FreshBooks accounting software can help streamline tracking and organizing expenses, making tax preparation fees easier to manage.

2. Consider Changing Your Business Structure

Switching to an S Corporation can help significantly lower your self-employment tax liability. When operating as an S Corp, you pay yourself a reasonable salary subject to self-employment taxes, while the remaining profits can be distributed as dividends, which are not subject to these taxes.

For example, if your net business income is $75,000, you could designate $50,000 as salary and distribute $25,000 as dividends, reducing the amount of income subject to self-employment taxes.

This structure may involve more paperwork and costs, but the savings on payroll taxes can outweigh these additional expenses. Consult a tax professional to determine if restructuring makes sense for you.

3. Claim All Eligible Deductions

Taking full advantage of deductions is key to reducing your taxable income. Common deductions for self-employed people include:

• Home office deduction: Deduct a portion of your home expenses (e.g., rent, mortgage interest, and utilities) used exclusively for business.
• Health insurance premiums: Deduct the cost of your private health insurance.
• Credit card interest: Deduct qualifying interest charges for business-related purchases.
• Mileage deduction: Deduct expenses for using your vehicle for business purposes.

Additionally, you can deduct half of your self-employment taxes as an adjustment to your adjusted gross income, lowering your overall income tax burden.

If you want to lower your self-employment taxes, you should look for (and claim) as many deductions as possible. If you’re not sure what you can deduct or how to do it, refer to the Internal Revenue Service guide to business expense resources.

4. Take Advantage of Tax Credits

Tax deductions and tax credits often get lumped together. But if you’re not taking advantage of both, you’re missing out on a solid opportunity to lower your self-employment taxes.

What, exactly, is the difference between the two? As mentioned, tax deductions lower your taxable income. For every dollar you deduct, your taxes are cut by a percentage of that deduction, which is based on your tax bracket. So, for example, if you’re in the 15% tax bracket, your tax is cut by 15 cents for every dollar you deduct.

Tax credits, on the other hand, lower your actual tax dollar for dollar. So, if you have a tax credit of $500, that credit will actually lower your taxes by $500.

If you’re eligible for tax credits, they can dramatically reduce the amount you owe in taxes—including self-employment taxes.

Tax credits offer a direct reduction in your tax obligations, unlike deductions, which lower your taxable income. Examples of relevant tax credits include:

• Disabled Access Credit: This provides up to $5,000 in tax credits to business owners who spend money to make their businesses more accessible for people with disabilities (like installing a ramp).
• Research Credit: If you spent a substantial amount of money on research and development, you might be eligible for the qualified research expenses credit, which provides tax credits for things like environmental testing, developing and applying for patents, and prototype development.
• Work Opportunity Credit: If you hire employees, consider hiring people who’ve traditionally faced barriers to employment, as you may be able to claim the Work Opportunity Tax Credit. This credit is for companies that hire veterans, ex-felons, Supplemental Nutrition Assistance Program (SNAP) recipients, and long-term unemployment recipients. For each person from a targeted category you hire, you can claim a credit of up to $9,600.

Investigating and claiming applicable tax credits can make a significant difference in reducing both your self-employment taxes and overall tax bill.

5. Invest in Retirement Savings

There are a million reasons why investing in your retirement is a good idea (the least of which is, you know, having money to retire with). But if you need an added incentive to start stashing cash away, contributions to eligible investment accounts are tax-deductible. They won’t reduce self-employment taxes, but they do reduce your federal income taxes.

Contributions to eligible retirement savings accounts are tax-deductible and can help reduce your taxable income. Options include:

• Traditional IRA
• Simplified Employee Pension (SEP) IRA
• SIMPLE IRA
• Individual 401(k)

These plans not only lower your taxable income today but also prepare you for a financially secure future.

Keep in mind that there’s no one-size-fits-all solution to retirement planning. The type of account (or accounts) that are going to make the most sense for you depends on your investment goals, savings strategy, and how much you plan to contribute each year.

If you’re unsure how to best plan (and save) for your retirement, talk to a qualified financial advisor.

6. Open a Health Savings Account (HSA)

In addition to retirement accounts, there’s one other kind of account that can help lower your taxable income—and that’s a Health Savings Account (HSA).

If you have a high-deductible health plan (HDHP), you may qualify for an HSA, which allows you to set aside pre-tax dollars to pay for qualified medical expenses. Contributions to an HSA reduce your gross income, thereby lowering your federal and state taxes.

For 2024, the contribution limits are $4,150 for individuals and $8,300 for families. HSAs also roll over from year to year, letting you save for future medical expenses tax-free. Because contributions aren’t taxable, the money you put into your HSA will lower your taxable income.

If you’re not sure if you qualify, talk to your insurance company to determine if your plan is considered an HSA-eligible HDHP.

7. Keep Accurate Records

Maintaining thorough and accurate financial records is essential for identifying all potential tax write-offs and reducing errors in your tax return. Keep track of actual expenses, including:

• wages paid to contractors or employees
• business assets like equipment and property
• tax preparation fees

Using accounting software or hiring a professional can help ensure you don’t miss out on eligible deductions or credits during tax season.

By implementing these strategies, you can effectively lower your self-employment tax liability and keep more of your self-employment income for growing your business and meeting personal goals. Always consult with a tax advisor to customize these strategies to your unique financial situation.

Get out There and Lower Your Self-Employment Taxes

Taxes—and, in particular, self-employment taxes—are a tricky beast.

The whole scenario is a double-edged sword: The more money you make as a self-employed person, the more you’ll pay in self-employment tax, and the less you’ll have in your bank account.

But now that you know the best strategies to reduce your self-employment tax costs, you have everything you need to slash your self-employment taxes (and keep more of your profits in your pocket in the process).

This post was updated in December 2024.