Self-Employment Tax - Question from Reader

Dear Tax Guide,
I appreciate the help you have provided on this web site. You wrote a response to some one asking about the SE tax. While I don't think I can quite claim that my profit was under $400 I would certainly like to be able to avoid the whole social security Self Employment tax anyway. What can I do to not pay, or opt-out of the social security program all-together?

Dear Reader,

You cannot avoid the Self Employment Tax. Just like you cannot avoid income taxes, sales tax, or any other legal obligation. However, you can minimize your taxes. And you can make decisions so that you aren't subject to certain taxes. For example, you won't pay sales tax if you don't buy anything. That's an extreme example.

If you work, you are subject to either the FICA or the SECA taxes. Every worker is subject to one of these laws. You cannot opt out of these requirements. FICA is the law governing ordinary employees, and provides that employees and employers pay Social Security and Medicare taxes on the worker's salary. Under FICA, the employee pays half of the FICA tax, and the employer pays the other half. The tax is 15.3% of wages, so each party pays half or 7.65%. As a self-employed person, however, you are both the employer and the employee. Your situation is governed under SECA. You pay the full 15.3%, but you get an above-the-line tax deduction for half of the Self-Employment tax. This places you in roughly the same financial situation as an employee.

Now, as I mentioned in my earlier response, you won't have to pay the Self-Employment tax if your net profits as reported on your Schedule C is $400 or less. However, if you continually report earning $400 or less income each year, this may raise serious questions about how you support yourself, or if you are claiming excessive business expenses.

Now, that being said, I think there are really smart ways to manage your overall tax situation. (Notice, I said overall. Self-Employment tax is one part of your overall tax scenario and should be taken into account.) One of the things you can do as a self-employed person is to manage your cash-flow wisely. Towards the end of the year, evaluate your profitability, and decide whether your business can afford to buy extra equipment, supplies, or technology. Also, take a look at your overall expenses. Perhaps you can reduce your profits by hiring employees, expanding your office, or upgrading your software. Expenses will reduce your profit, and will reduce your taxes.

Finally, focus more on making money than on saving on taxes. As a self-employed person, the more money you make, the more you will be able to save, to invest, to grow your business, and to create the life you envision. While taxes is a big part of your financial planning, don't be afraid to grow you business.

Hoping you prosper,

William