If you don't understand how to lower your self-employed taxes, you might be paying more than you need to. Here's how to make sure that doesn't happen.
Paying taxes isn’t a particularly fun activity for anyone—but it can be especially tough on the self-employed. Not only can the filing process feel confusing (How much do I need to pay? What forms do I have to fill out? When are the deadlines?), but you’re also faced with the harsh reality of just how much of your income is actually funneled into self-employment taxes.
The not-so-great news? As a self-employed person, if you’re bringing in income, there’s no real way to get around it, you have to pay self-employment tax. But the good news? Just because you can’t avoid paying self-employed taxes entirely doesn’t mean you can’t reduce the amount you owe come tax time.
Since you have no choice but to pay self-employment tax, let’s look at the different ways to minimize the impact of your self-employed tax on your income—and pocket more of the money you make from your business.
Keep in mind that this is just a general overview of these strategies—and before you make any decisions on your taxes, you should plan to speak with a tax advisor or accountant about the specifics of your situation, to help you properly pay self-employment tax.
What Is Self-Employment Tax?
Before we jump into how to lower your self-employed taxes, how to pay self-employment tax, and your self-employment tax rate, let’s quickly cover what self-employment tax actually is.
Self-employment taxes are…well, exactly what they sound like. They’re taxes on income brought in by self-employed people (freelancers, solopreneurs, small business owners, etc). How those taxes are structured and what they’re used for vary by country.
For example, in the U.S., the self-employment tax is how self-employed individuals (i.e., sole proprietors and partners in a partnership) pay their social security tax and Medicare tax. Whereas, in Canada, self-employment taxes include Canada Pension Plan (CPP) contributions as well as federal and provincial income tax.
Who is liable for paying self-employment taxes—and how much they’ll pay—also varies by country. For example, in the U.S., anyone who makes more than $400 per year of self-employment income must pay self-employment taxes at the current self-employment tax rate of 15.3%, which breaks down to 12.4% for social security tax, and 2.9% for Medicare tax.
In Canada, self-employed individuals must pay the Canada Revenue Agency (CRA) 11.4% of their income (up to a maximum of $6,999.60) to cover their CPP contributions. In addition to this, you’ll pay federal and provincial income tax, but the rates will depend on your overall taxable business income (net earnings). Remember, these amounts are calculated on your net income (gross income less allowable expenses). You also can opt into the Employment Insurance program (E.I.) to cover your wages if you become sick or would like to take parental leave.
Bottom line? How much you’ll pay in self-employment taxes (and what those taxes are ultimately used for) will depend on where you live. But whatever country you call home, there are ways you can lower your self-employment taxes—and bank more of your income in the process.
5 Ways to Lower Self-Employed Taxes
1. Increase Your Business Expenses
It might sound counterintuitive, but as a self-employed individual, spending money on your business throughout the year can actually help you save money during tax season.
Your self-employment taxes are based on your earnings from self-employment (net income). And because business expenses reduce that net income, they also reduce the amount you’ll owe in self-employment taxes. The best way to do this is to make any planned purchases before the end of the tax year. This also applies if you’re an independent contractor.
So, what kind of expenses might help lower your self-employed taxes? Eligible business expenses include things like office supplies, education, advertising, and labor costs. Basically, if it’s money spent on keeping your business up and running, it’s considered a business expense—and will reduce the amount you’ll owe in self-employment taxes come tax time. Any money spent on purchasing equipment and other assets is also deductible. Still, it will be spread out over several years depending on the type of asset and the capital asset rules in your country.
Just make sure you’re keeping track of all of your expenses. If you’re claiming something as a business expense for tax purposes, you need to document it.
Want to make the process of documenting your expenses as simple as possible? With cloud accounting tools like FreshBooks, all you need to do is connect your business account—and we’ll take it from there, automatically tracking and categorizing your expenses to make filing your taxes as streamlined as possible.
2. Look for Deductions
Deductions are another way to lower your taxable income—which, in turn, will reduce your self-employed taxes.
The deductions you can claim as a self-employed person will vary based on where you file your taxes, but some common deductions include:
- Did you take out a loan to start your business? You may be able to claim a deduction for any interest paid on that business loan over the course of the year.
- Do you use your car to meet clients or conduct business on a regular basis? You may qualify for a deduction based on your mileage.
- Does your country have private health insurance—and, if so, do you pay for it out of pocket? If so, you may be able to claim your premium costs as a deduction.
The point is, there are plenty of deductions available for the self-employed—and if you want to lower your self-employed taxes, you should plan to look for (and claim) as many deductions as possible.
3. Work From Home
Working from home can offer self-employed people more than just the ability to eliminate a long commute (and work in their pj’s!). It can also help to significantly reduce self-employment taxes.
For example, in Australia, when you run your business from home, you can claim deductions both for occupancy expenses (including rent and mortgage interest), phone and internet, and running expenses. These are defined as “the increased costs from using your home facilities for your business,” including lighting, heating, and cooling costs.
Meanwhile, in Canada, you can deduct a percentage of your home expenses (including utilities, rent, mortgage interest, and property taxes) as a home business tax deduction, which is calculated based on the size of your home office—and what percentage of space that office occupies in your home.
After all, when you work from home, a portion of your home expenses are going towards keeping your business up and running—and you can often deduct those expenses as a way to lower your self-employment taxes. If you’re not sure how—or how much—to deduct in home office expenses, check with your country’s tax authorities for further clarification.
4. Take Advantage of Tax Deductions and Credit
Tax deductions and tax credits often get lumped together. But they’re not one and the same—and if you’re not taking advantage of both, you’re missing out on a solid opportunity to lower your self-employed taxes.
But what is the difference between the two?
As mentioned earlier, tax deductions lower your taxable income. For every dollar you deduct, your taxes are cut by a percentage of that deduction based on your tax rate. For example, if you’re taxed at a rate of 15%, your tax is cut by 15 cents for every dollar you deduct.
On the other hand, tax credits lower your actual tax dollar for dollar. So, if you have a tax credit of $500, that credit will reduce your tax amount by $500.
Basically, tax credits are like supercharged tax deductions—and, if you’re eligible for them, they can dramatically reduce the amount you owe in taxes (including self-employed taxes).
There are a variety of tax credits available to small business owners across the globe. For example:
- In the U.S., the disabled access credit 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). For a complete list of U.S. tax credits, check out this article.
- In Australia, individuals who make less than $37,000—including self-employed individuals—may qualify for the Low Income Super Tax Offset (LISTO), which helps lower-income earners save for retirement with a government contribution of up to $500.
- In the U.K., self-employed individuals may qualify for the Working Tax Credit of up to £3,040 per year.
- In Canada, self-employment income makes you eligible to apply for the Canada Workers’ Benefit, a tax credit of up to $1,000 per year.
Keep in mind that, depending on where you live, and what tax credits are available, not every tax credit offered will be relevant to you and your business—but the potential for significant savings makes tax credits a strategy worth investigating.
5. Invest in Eligible Retirement Accounts
There are a million reasons why investing in your retirement is a good idea. But if you need an added incentive to start stashing cash away for your golden years, contributions to certain eligible investment accounts aren’t taxable—and that includes self-employed taxes.
Examples of investment accounts for self-employed individuals that are eligible for pre-tax contributions include:
- Traditional IRAs (U.S.)
- Self Employed Pension (SEP) IRAs (U.S.)
- Individual 401ks (U.S.)
- Registered Retirement Savings Plan (Canada) (these contributions don’t reduce CPP owing, only the income tax)
- Superannuation (Australia)
Keep in mind that there’s no one-size-fits-all solution to retirement planning. The type of account(s) that are going to make the most sense for you depend on where you live, your investment goals, your savings strategy, and how much you plan to contribute each year.
Not sure how to best plan (and save) for your retirement? Talk to a qualified financial advisor to develop a retirement plan that works for you and your financial situation.
Get Out There and Lower Your Self-Employed Taxes
Taxes—and, in particular, self-employed taxes—can be a tricky situation to navigate. If you need to talk to a tax professional or your accountant about the best way to lower your self-employment taxes.
In certain ways, it’s a double-edged sword. The more income you pull in as a self-employed person, the more you’ll owe in self-employed taxes—and the less you’ll have in your bank account as a result.
But now that you know the strategies you can use to lower your self-employed taxes, you have everything you need to find ways to slash your self-employed tax liability, and pocket more of your profits in the process!
about the author
Melanie is a Registered Professional Counsellor and a Chartered Professional Accountant (CPA, CGA) and founder and CEO of Out Of The Box Chartered Professional Accounting. For Melanie, accounting has always been about helping small and medium-sized businesses grow.