The Biggest Loser is a TV show where contestants attempt to lose the most weight for cash prizes. Full Disclosure: I don’t watch the show and I have only seen short clips of it. I don’t proclaim to fully understand the show. It appears to me however the biggest loser has nothing to do with losing weight. It’s the self-employed in Connecticut. They are losing far too much to income taxes. And they certainly aren’t getting any cash prizes for it. For this discussion, the self-employed include sole proprietors, single member limited liability companies (“LLC’s) and partners in partnerships. It does not include owners of “C” Corporations or Subchapter S Corporations.
Do the Math
Here are the approximate tax rates a self-employed person in Connecticut would face in 2012: Federal Income Tax 25% Social Security Tax (up to $110,100) 15.3% Connecticut Income Tax 5% Add it up and the marginal tax bracket is over 45%. The good news for the self-employed in Connecticut is that there are states with higher tax rates!
What can a Connecticut self-employed taxpayer do?
- Open an IRA – Taxpayers under age 50 can contribute up to $5,000. Taxpayers age 50 or older can contribute another $1,000 or up to $6,000.
- Fund a Simplified Employee Pension (“SEP”) – Self-employed taxpayers can contribute up to 20% of their net income not to exceed $49,000 in 2011 and $50,000 in 2012.
- Fund a Connecticut Higher Education Trust (“CHET”) 529 plan – A married couple filing a joint return can deduct up to $10,000 on their Connecticut income tax return for amounts funded into a CHET.
- Hire their spouse- At the very least, the spouse may then become eligible for an IRA or, perhaps, participate in a SEP.
- Hire their children under age 18 – Children under age 18 that work for their parents unincorporated business do not pay social security tax on their earnings. Just to be clear…the children need to actually work however.
- Consider incorporating and making a Subchapter S Corporation – Taxpayers may want to consider becoming an employee of their corporation. A more detailed analysis would need to be done to see if this is appropriate in your particular situation.
ACTION ITEM: To avoid being The Biggest Loser, the self-employed in Connecticut need to be vigilant about their income tax planning.
Thomas F. Scanlon, CPA, CFP®
Photo from Creative Commons