Before You Calculate Self-Employment Tax, Do This

What should you do before you calculate self-employment tax as a small business owner? Summarized, do some planning. This is not an article about the math, as that is simple. The self-employment tax rate for 2021 is 15.3%. This is made up of 12.4% for Social Security and 2.9% for Medicare. The value in this article is not that simple math calculation. Instead, it is understanding your current and financial situations and determining as much as you can how much you pay in self-employment taxes.

This is a planning process that is dependent on the time of year. You could be planning on actions for the current tax year or for the next and future tax years. The point is that as a small business owner you have some control over how much you pay into Social Security and Medicare. That is because the tax is paid on the net income of the business after all appropriate tax credits and deductions.

There are many decisions you make each year in business that influence your profitability as reported to the IRS. You will pay that 15.3% on the reported on net income. Here are some considerations and decision points over which you have some control, and they change that bottom-line income figure for when you calculate self-employment tax.

  • The Big Picture Present and Future – Do you have other retirement plans into which you are contributing significant funds? If so, are they qualified plans that allow you to deduct some or all the contributed amounts from taxable income? If so, you may want to forego taking out money if you can contribute more to those plans in before tax dollars.
    If your retirement plan is not qualified for deductible contributions, you may want to transfer the funds into a new one that will allow deductible contributions from business income. If you have no other retirement accounts and do not want to form one, you may want to run up your income for self-employment taxes to build for Social Security later. Of course, this is only if the business is doing well.

  • Income and Expense Management – In any given year, you may want to defer income or expenses into the next year if allowable. Or, it could be in the other direction, accelerating income or expenses into the current year to reduce taxable income. If your business is growing, you may be considering expansion of facilities or the purchase of major equipment or vehicles. If so, you want the advice of a tax professional as to whether leasing or buying is better. If you purchase, then you want to make the right decisions as to how to depreciate their value.

In case you have not caught onto the goal here, it is all about taxable business income and expenses that can be manipulated to determine how much you end up paying in self-employment taxes. Once you pull your plan together based on your current and future goals, then calculate self-employment tax at that 15.3% rate.


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