While it’s not as easy to lower your self-employment tax as it is to lower your income taxes, there are still moves you can make.
Self-Employment Tax vs. Income Tax
The self-employment tax is both a business and personal tax, while income tax is a personal tax.
Self-employment tax usually consists of 12.4% for Social Security tax plus 2.9% for Medicare tax for a total self-employment tax of 15.3%. Higher earners only pay Social Security tax on their first $160,200 in income (as of 2023, adjusts for inflation).
In a typical employer-employee relationship, the employer and employee each pay half of the 15.3% tax. That works out to 7.65% each.
Self-employed workers, including independent contractors and small business owners, are responsible for both the employer and employee portions. When you’re running your own business, you are the employer.
By contrast, income tax is paid fully by the employee.
When you’re a business owner (other than a C-corporation) you don’t pay a business income tax. Instead, you pay your personal income tax rate on your net earnings.
Another difference with self-employment tax is that it goes towards specific benefits (Social Security and Medicare). That’s another reason the rules for self-employment tax deductions are different from income tax deductions.
What deductions reduce self-employment tax?
As a general rule, you only get a self-employment tax deduction for business expenses. That’s because your self-employment tax is based on your business income.
Tip: Get an accounting app so you don’t miss any deductions.
Both above-the-line and below-the-line personal deductions only apply to income taxes.
Take a look at IRS Form 1040. You’ll see that you add your income, subtract your deductions, and then figure your taxable income.
Turning to the next page, you figure your income tax and then add in your self-employment tax. Notice that you’ve already subtracted your deductions before you add in your self-employment tax.
Schedule 2 just copies your Schedule SE (self-employment tax) and Schedule SE takes your net profit from Schedule C.
The 1099 deductions list on Schedule C includes:
- Advertising expenses
- Car and truck expenses
- Commissions and fees
- Contract labor
- Business insurance premiums
- Office expenses (including the home office deduction)
- Travel and meals
- Other expenses directly related to your trade or business
So if you can deduct it from your business income, it will reduce your self-employment tax.
Caution: Reducing your self-employment tax also reduces your earnings for Social Security. This can result in lower Social Security retirement benefits.
Deductions That Don’t Reduce Self-Employment Tax
Other deductions generally won’t reduce your self-employment tax. Even if your personal tax deductions are more than your taxable income and you owe $0 in income taxes, you can still owe self-employment tax if you had a net business profit.
For example, you either worked part-time during the year or just had a bad year. Your net earnings from your business were less than the standard deduction. The standard deduction wipes out your income tax, but it doesn’t reduce your self-employment tax.
Like the standard deduction, itemized deductions don’t reduce your business profit or your self-employment tax. Itemized deductions only reduce your taxable income for income tax purposes.
As a reminder, business expenses belong on Schedule C, Business Profit and Loss, rather than Schedule A, Itemized Deductions.
Qualified Business Income Deduction
It might seem weird that the QBI deduction doesn’t reduce self-employment taxes when it’s a deduction for business income. That’s just the way it is.
The idea behind the QBI deduction is that it’s for businesses that pass their income through to the owner’s personal tax return.
The QBI deduction doesn’t reduce your net profit. It only reduces how much of your net profit you have to pay income taxes on.
Self-Employed Health Insurance Premiums
The self-employed health insurance deduction is another deduction that seems like a business deduction but isn’t. So it doesn’t reduce your self-employment income or self-employment tax.
The idea behind the self-employed health insurance deduction is that when an employer pays for an employee’s health insurance premiums, the employee doesn’t pay income taxes on that benefit.
When you’re self-employed, the self-employed health insurance deduction effectively lets you use pre-tax dollars instead of after-tax dollars to buy your health insurance.
(Yes, it’s not fair that you don’t get a self-employment tax break on your health insurance premiums when employees don’t pay FICA tax on employer health insurance benefits.)
Deduction for Half of Self-Employment Taxes
The deduction for half of self-employment taxes also only applies to income taxes. It doesn’t reduce self-employment tax.
But there is an easily missed benefit here. Your self-employment tax is actually based on 92.35% of your business profit not 100%.
The 92.35% accounts for the 7.65% employer portion of self-employment taxes.
Since you already get a break when you calculate your self-employment tax, you don’t get another self-employment tax deduction when you subtract half of your self-employment tax from your Form 1040 taxable income.
Other Personal Tax Deductions
There are other personal tax deductions that you claim separately on your tax return. These also reduce your income tax but don’t give you self-employment tax deductions.
- Education expenses
- Retirement savings
- Mortgage interest
- Student loan interest
Refundable Tax Credits
Refundable tax credits can reduce your self-employment taxes.
Refundable tax credits count as payments towards your taxes after you already added your income tax and self-employment tax together. Examples of refundable credits include the child tax credit, earned income tax credit, and American opportunity tax credit.
So if you’re trying to reduce your self-employment tax, don’t just look for more business expenses. See what tax credits you can qualify for as well.