Tax Strategies for Small Business Owners to Save on Self-Employment Taxes

Running your own business comes with many rewards including freedom, flexibility, and the chance to build something meaningful. Unfortunately, it also comes with its share of financial responsibilities, including self-employment taxes.

What are Self-Employment Taxes?

These taxes you normally don't think about as an employee, as you pay them through your paycheck. They can be a surprise expense for many first-time entrepreneurs.

They are a collection of both medicare and social security taxes that are taxed at 15.3% percent of your income. If you were an employee, you would be paying half, 7.65% on your income, and the other half was paid by your employer. As a self employed person, you will pay the full 15.3% and be able to take a deduction for the employer portion on your tax return.

The good news for self-employed individuals? With thoughtful planning, you can take steps to reduce the impact of self-employment taxes. Here are some practical strategies small business owners can use to manage and potentially lower their self-employment tax liability:

1. Choose the Right Business Structure

How your business is structured plays a significant role in how much self-employment tax you pay. Sole proprietors and partners must pay self-employment tax on all net earnings, but making an S Corporation election may offer savings. As an S Corp, you can pay yourself a reasonable salary, which is subject to these self-employment taxes, and treat remaining profits as distributions, which are not subject to self-employment tax.

This strategy can create significant savings over time, especially if your business generates more income than you would reasonably pay yourself as a salary. However, with this entity you need to have more separation between your personal and business life, as well as an increase in costs, like payroll and tax compliance related to being compliant. It generally is recommended that this strategy isn't explored until the business is making at least $70,000 a year due to this increase in cost and complexity and seperation, as well as potentially losing out on the tax savings for the Qualified Business Income deduction at least through 2025 unless it is not extended.

Classic cases of separation in this entity include if you use business assets for personal uses, that personal use is subject to payroll taxes, as well as if you pay expenses or drive personal vehicles, you need to maintain documentation that you were reimbursed timely by the S-corp. A way to frame it is that you're an employee of the company first before you are an owner. A small price to pay for potential tax savings.

2. Contribute to Retirement Plans

Everyone should be saving for retirement, especially business owners who have the ability to diversify their holdings beyond their business. Retirement contributions not only help you save for the future but can also reduce your taxable income. Consider contributing to a SEP IRA, SIMPLE IRA, or Solo 401(k). These plans allow for high contribution limits, particularly the Solo 401(k), which lets you contribute both as an employee and employer. For example, in 2025, you can contribute up to $70,000 between your employee and employer contributions if you're under 50 (more if you're 50 or older with catch-up contributions).

These contributions reduce your taxable income, thereby lowering both your income and self-employment taxes. Plus, retirement plans can be a valuable tool for attracting and retaining employees if you plan to grow your business.

3. Rent Personally Owned Real Estate to Your Business

If you own property personally, you might consider renting it to your business. This strategy can shift income from self-employment earnings to passive rental income, which is not subject to self-employment tax. Common examples include renting an office, workshop, or storage space you personally own. It’s essential to establish a formal rental agreement at fair market value and document all transactions thoroughly, as well as making sure the space is relevant and actually being used by your business. This not only supports tax savings but also provides a clear audit trail.

Keep in mind that rental income is still subject to income tax, and depreciation or maintenance costs can help offset it. Always consult with a tax professional to structure this correctly and avoid any potential pitfalls, such as the IRS reclassifying the rental arrangement.

Final Thoughts

Self-employment taxes are a large reality for small business owners, but with careful planning and strategic decisions, you can manage and even reduce your liability. Start with these tips, and consider making tax planning a year-round effort with a tax profesisonal rather than a once-a-year scramble. Your future self, your bottom line, and your accountant will thank you.