A New Tax Break for the Self-Employed

Posted on September 29, 2010 by Grant Brisacher

This is really good news for self-employed people and helps reduce the “double whammy” of FICA taxes for self-employed individuals.

A New Tax Break for the Self-Employed


There’s a new tax break for the self-employed buried in the small business jobs legislation that was signed into law on Monday.

Self-employed workers who pay their own health insurance premiums have always been able to deduct those costs, along with premiums for family members, when calculating their federal income taxes. The new law allows them to also deduct those costs before computing their self-employment taxes, also known as payroll taxes, which cover Social Security and Medicare.

Before the new law, which is only scheduled to last until the end of this year, self-employed people had to pay payroll taxes on their entire income, said Kelly Phillips Erb, a tax lawyer in Philadelphia who wrote about the new provision on her blog, TaxGirl.

This is a welcome little break — payroll taxes, after all, are far more burdensome for the self-employed than regular employees. That’s because the self-employed — generally sole proprietors, freelancers and the like — must pay the entire 15.3 percent tax on their own. Workers, meanwhile, typically split payroll taxes with their employers: each pays 6.2 percent of the employee’s gross income to cover the Social Security piece and each pays  an additional 1.45 percent for Medicare.

So consider a self-employed taxpayer who earns $100,000 annually and pays $10,000 for her family’s premiums. Last year, she would have owed roughly $15,000 in self-employment taxes. This year, thanks to the new law, she’ll pay about $13,500 — a $1,500 savings.

“It’s almost like you are getting a 15 percent discount on your premiums,” Ms. Erb said, because many self-employed people will save about 15 percent of what they pay for their health insurance.

But the size of the tax break declines as your income increases, Ms. Erb said. Social Security taxes are owed only on income up to $106,800. So to receive the break on the Social Security portion of your payroll taxes, your deduction for the health insurance premium must reduce your income below $106,800. So a person who earns $130,000 and pays $10,000 in premiums will owe payroll taxes on $120,000 in income. Since Social Security taxes are only owed on income up to $106,800, the tax break doesn’t help.

But the taxpayer will still owe less in Medicare taxes, since there is no cap on the 2.9 percent tax.

“Basically, the savings could be as little as the Medicare portion or as big as the Medicare and Social Security portion,” Ms. Erb said, “depending on where you are on the income scale.”

The National Association for the Self-Employed said it expected that the new provision would save self-employed business owners anywhere from  $456 to $968, on average. It based those numbers on the average premiums paid by single individuals and families.

“We and other small business groups hope to push for this to become permanent, but at the very least we will work to keep extending it,” said Kristin Oberlander, a spokeswoman for the association.

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