All employed people are required to pay both medicare and social security taxes. W2 wage earners have employers who pay one half of those tax and they pay the other half which is taken out of their gross pay and listed on their pay stubs.
For self-employed people, since we don't have an employer to pay half of medicare and social security, they pay both halves and this is what makes up self-employment taxes. The percentage of net income that is taxed is just over 15%, so if you need to estimate how much to set aside it is at least 15%. I always tell my clients to save a minimum of 20%. You can find more info on the SE tax here.
Since the amount of SE tax is dependent on your net income the most effective way to reduce it would be to claim as many legitimate expenses as possible. A lot of business owners know their business well but don't really have an idea of what is a legitimate business expense. Sometimes business owners hear from a friend that they should be deducting this or that but the reality is if your friend isn't a qualified and experienced tax professional they shouldn't be giving you tax advice. Always consult with your tax professional before counting on expenses that may not be deductible.
Business expenses are different for every type of company but one thing nearly all companies have in common to deduct are utilities such as phone and internet. Many home based businesses can deduct Home Office expenses including a portion of the utilities paid for the entire home; this is also an excellent way to reduce net income.
Below are a few more expenses that might apply in general to most businesses:
- Actual expenses (oil,gas, maint. etc) OR mileage for vehicles used in business endeavors
- Tax Prep fees
- Office supplies
- Utilities (home based or office)
- Monies paid to independent contractors
- Advertising and marketing
Next week I am going to be writing about how SE net income is essentially taxed twice. Once as ordinary income and again as self-employment income.