This is "Shark Week" on the Discovery Channel. We are (not so gently) reminded not to swim with the sharks.
For the self-employed in Connecticut, every week is "Shark Week". A self-employed person is someone who runs their business as one of the following entities:
- Sole Proprietor
- General partnership with the spouse as the only other partner
- Single Member Limited Liability Corporation ("LLC")
- An LLC where the spouse is the only other member
For this discussion, we are not including business owners that have either a corporation or have elected Subchapter S filing status.
The self-employed in Connecticut have to deal with a much more difficult shark than the ones in the ocean. They have to deal with land sharks, also known as the tax collectors that want a piece of you.
For example, a self-employed person lives in Connecticut with his wife and two children. He makes $100,000 a year. They do not itemize their deductions and to keep the example straight-forward, we are ignoring any possible tax credits they may be entitled to. Here is the income tax they will pay based on the 2009 tax tables:
- Federal Income Tax (The Great White) ― $9,204
- Social Security Tax (The Hammer Head) ― 15.3% social security tax on their net income of $100,000 would be $14,130 (the calculation is slightly different). They are allowed to deduct one-half of this tax in calculating their federal income tax.
- State of Connecticut Income Tax (Jaws) ― $3,822
Let's add these up…federal income tax of $9,204, social security tax of $14,130, and Connecticut income tax of $3,822. Total taxes are $27,156. That's a big shark bite!
What can a self-employed business owner do to minimize this?
- Fund your IRA – this is a great tax-deferral tool to provide for your retirement.
- Look at a 401(k) plan or SEP – these qualified retirement plans may allow you to contribute more to your retirement.
- Hire your children under age 18 – if you are eligible, this is a great way to hire your children and save taxes.
ACTION ITEM: The self-employed business owner needs to be aware of the tax planning techniques available to reduce their tax bite.
Thomas F. Scanlon, CPA, CFP®