A few years ago, when I first started earning a good sized income from home, I was somewhat shocked to discover that on top of my normal income tax rate, I was required to add on another 15.3 percent in what’s known as self employment tax.
Fortunately, I discovered a legal strategy that saved me $7,000 the first year I implemented it.
DISCLAIMER: I’m not an accountant or an attorney so what I’m about to share should not be construed as legal or professional advice and is for information & educational purposes only. Please check with your tax or legal professional before making any important decisions relating to your tax and accounting strategy.
Basically it goes like this.
Your business income (active income) is paid to an LLC with an S corp election.
Let’s say you earn $200K in income and have $100K in expenses so your taxable income is $100K.
If you were to pay 15.3% in taxes on this $100K – your tax bill here would be $15,300 dollars and remember this is on TOP of your federal and state income taxes.
DANG GINA!
So here’s what you do to save some money there.
You set up monthly payroll check to yourself from your business.
What happens then is you then pay self Employment tax on the amount you pay yourself in your monthly check and NOT on the total amount of profit you made in your business.
According to nationally known tax expert Mark J Kohler, a good rule of thumb here is a 2/3 1/3rd split.
This just means that 2/3 of your income can be profit to your business and 1/3 can be salary in the form of a paycheck to you.
So in the above example you’d pay yourself $2,750 per month in Salary ($100,000 X .33 (for the 1/3rd split) and then divided by 12 to get your monthly amount)
Now you pay the 15.3% of self employment tax on your paycheck.
15.3% on $2,750 over a year comes out to $5,049 in Self Employment tax.
That’s over $10,000 less than it would have been on the original $100,000 in income.
Can you say WOW!
This 1 strategy alone saved me $7,000 in taxes the first time we implemented it a few years back.
It’s also a good idea to review these numbers on a yearly basis to make sure you’re not underpaying or worse, overpaying on self employment taxes.