Many business owners are upset about the seemingly high marginal tax rates of income taxes imposed upon small businesses. Besides the income tax (which has brackets ranging from 15% to 39.6%) self-employed people also pay a 15.3% self-employment tax (for social security). To make this even more painful, your itemized deductions (things like home mortgage, state and local taxes paid, charitable contributions, etc.) are phased out at higher income levels. Likewise your exemptions are eventually eliminated at more rarified income levels. And to make sure there is truly no escape, the IRS imposes an alternative minimum tax to offset too many deductions with a minimal level of taxation. Of course, you must add state, county and local income taxes for your jurisdiction on top of these high rates.

What many small business owners forget is that all of these huge tax burdens are imposed on NET PROFIT - not gross income. While the wage earners who work for you must leave all of their earnings hanging out fully exposed for the IRS to extract their cut before the worker even sees the funds, you have the flexibility to change your taxable income. So let's take a look at how we can cut that profit with additional deductions.

Before we get started, just take note of one special point. No matter how high your income gets, business expenses are never phased out or eliminated. Now let's look at how we can create some tax writeoffs. Suppose we first discuss sole proprietors (who file schedule C as part of their personal returns) and farmers (a special type of sole proprietors who file schedule F as part of their personal returns).

Sole Proprietorships
If you have a family, you can cut your tax bill substantially. Any sole proprietor who hires his own kids under age 18 is exempt from both the child labor laws and all payroll taxes. Therefore paying your kids for assistance up to $4,600 for 2005 (this number is indexed, so it will increase slightly each year) will allow you to cut your tax bill while costing no federal taxes on your child's return. However, you may generate some state or local income taxes for your child, but these should be minor amounts compared to the big savings you will receive on your federal return.

Another great idea is to hire your spouse. You will have to pay payroll taxes on his or her wages, so at first this may not seem worth the effort. However, you can offer employees (including your wife) a fringe benefits package. Let's say you offer your spouse family medical insurance, life insurance, and child care (there are several other benefits you can offer also). Now you can deduct 100% of your health premium, but not your spouse or kids as an adjustment off income taxes, and none of it off the self-employment tax. Life insurance gets you no tax deduction at all. If your spouse does not work outside the home for a wage, then child care expenses would not generate any tax savings either. Even if he or she works outside the home, you can get a child care credit off income taxes, but not self-employment taxes. Yet if you offer these as part of a benefits package, you can deduct all three fringe benefits 100% off both income and self-employment taxes!