For many people who work for a standard employer, the Social Security portion of their payroll tax is divided between employee and employer. As a self-employed individual however, I’m responsible for paying both sides of the Social Security tax. This aspect of income taxes might seem pretty cut and dry. The federal government sets a standard rate — in this case 12.4 percent (not factoring in Medicare tax costs or the federal deduction for the employer side of this tax) — and I pay it, right?
But it’s not always as simple as that. There are issues involved that could make reporting more or less income — without breaking any tax laws of course — pertinent to my retirement future.
Deductions can weigh heavily upon income
As a self-employed individual, business-related deductions can play a big role in my overall tax reportable income. In turn, this can also affect how much I pay in things like state and federal income taxes, and yes, Social Security tax. And considering that I have to pay both sides of things like Social Security and Medicare taxes, and adding in state income tax, I can save nearly 15 percent tax on every dollar that’s not reportable income without even factoring in federal tax rates. Now I’m not advocating shady practices of any sort to push deductions higher, but if such things are available for deductions — travel expenses, office supplies, and related work materials — I might as well take them to save myself some money, right? Well, not necessarily because there are other things to consider.
Long-term benefits and repercussions
So cutting my tax would be a good thing, right? I mean, why would anyone in their right mind want to pay more in taxes? Well, I’ll tell you why.
Think of it this way, as a self-employed individual, I don’t have an employer-sponsored retirement plan with matching contribution, and if I did, I’d be sponsoring it anyway, so it’s not such a great benefit. And even if I did, I’m not a big fan of stock market investing for retirement as the markets can often be fickle — and at times, downright financially dangerous — beasts in my opinion.
Even with all its problems, and the potential for reduced benefit payments in 2033, I still think that Social Security may be one of the better retirement plans out there. So cutting the amount that I’m paying toward such a plan now could just be reducing the amount that I’ll be receiving as benefits in retirement. On the other hand, if I’m smart with my tax savings, I could invest them now, earning money in the meantime or keeping debt at bay, creating savings of my own, and potentially protecting that money from issues with Social Security that might actually reduce my potential benefits further before I’m able to take them.
So you see, reducing taxable income can kind of be a double-edged sword, and it’s hard to say which action will be better over the long run.
Hedging bets as a happy medium
With such a hazy outlook on the issue of reducing my tax bill, I’ve kind of tried create a happy medium. Sure, as a self-employed individual, I still take business-related deductions on my taxes. This lowers the overall amount I’m taxed upon; however, I don’t always include everything I’m eligible for. I could take the home office deduction, certain travel expenses, and probably a variety of other expenses related to my work or research for that work.
So in a way, I’m kind of hedging my bets. This allows me to continue to pay into the Social Security system — maybe not as much as I could, but not as little either — so that I’m getting some tax savings for personal investing in the near-term, but also ensuring that there is a Social Security check there for me in retirement. In essence, I’m just not putting all my eggs in one basket when it comes to counting upon that Social Security check though.
More From This Contributor:
Building a Revenue Producing Blog
How I Differentiate My Blog
Preparing to Publish My First E-book
The author is not a licensed financial or tax professional. The information provided in this article is for informational purposes only and does not constitute advice of any kind. Calculations have not been verified by a professional. Any action taken by the reader due to the information provided in this article is solely at the reader’s discretion.