Let’s look at an example of how all of these things can
benefit the typical self-employed individual. Suppose you earned a net profit of
$85,000, which would place you in the 25% federal tax bracket, and have no other
sources of income, and you do not itemize. Also, suppose your state has an
income tax with an effective rate at your income level of 7% and uses federal
taxable income with no adjustments. The following is an idea of how you can cut
your tax bill:
Item
Normal Profit
With Tax
Reduction Ideas
Profit
85,000
85,000
Spousal wage
-0-
( 8,000)
Medical insurance
( 3,072)
( 9,600)
Life ins. & child care
-0-
( 5,000)
Wages for 3 kids
-0-
(9,300)
SEP plan contributions for spouse & 3 kids
(maximum)
-0-
(4,325)
SEP contribution for you (maximum allowed)
-0-
(23,237)
Loan of $10,000 from spouse @ 10% interest
-0-
(1,000)
Rent
-0-
(2,000)
Taxable income for income tax (assumes only
$400 for rental-related deductions for your spouse, taking 50%
adjustment for self-employment tax & 2005 exemptions)
44,195
-0-
Taxable profit for self-employment tax
85,000
55,075
Spousal payroll taxes (assumes 1.2% state
unemployment tax rate, includes both employee & employer taxes)
-0-
1,384
Income taxes (using 2005 rates + 7% state
rate)
9,005
-0-
Self-employment taxes
12,010
7,782
Total taxes
21,015
7,782
Net savings
11,849
Effective tax rate on $85,000 profit
24.7%
9.2%
From this example you can see how to cut your tax bill by as much as over
56%, and end up with no income tax at all, and also a lower effective tax rate than the
flat rate self-employment tax, even after paying the combined, federal, state,
employer, employee, and self-employment
taxes! With today's very steep tax brackets, the percentage savings can increase
substantially as you use the tax-saving ideas on higher incomes.
