Tax season may be over, but it’s never too early to start strategizing how you can save even more money next year! Freelancers, this post is for you. Our friends at Hyke are on a mission to help you start and maintain an S-Corp in an easy and affordable way—today their team is sharing two key tax saving strategies for 2019 to start implementing now.
Hey freelancers, we’ve got two tax savings strategies that require quite a bit of planning ahead of time. Unfortunately, it’s too late to take advantage of these savings for your 2018 taxes, but you can certainly implement these strategies this year in order to lower your taxes on your 2019 return and beyond. Let’s get started:
1. Form an S Corporation
- Want to know the most effective advanced tax savings strategy for most freelancers? Convert to S Corporation taxation! To do this, you’ll have to first form either an LLC or a corporation in the state where your office is located. Then, you’ll need to obtain S corporation tax treatment by simply filing IRS Form 2553, Election by a Small Business Corporation.
- This tactic can free you from much of your self-employment tax burden. Remember, self-employment taxes include the 12.4% Social Security tax and the 2.9% Medicare tax. Combined, that’s a 15.3% tax up to the Social Security tax ceiling (which is $132,900 in 2019). For many lower income freelancers, self-employment taxes exceed their income taxes, so these taxes can be their largest single business expense. Ouch!
- After you convert to S corp taxation, you become an employee of your business, so you won’t be a sole proprietor anymore. Your business will start paying you an employee wage, along with benefits.
You and your business will need to pay employment taxes (Social Security and Medicare) on your wages. Although you and your business will each pay half of the employment taxes, the total tax is the same as for self-employment taxes (15.3% up to the Social Security income ceiling).
- Another way this helps you save money: you don’t need to pay employment taxes on distributions paid to you as a shareholder—that is, on earnings and profits that pass through the business to you as a shareholder, not as an employee in compensation for your services.
The more your business pays you as a shareholder distribution, instead of as a salary, the less employment tax you and your business will have to pay on your business profits. (You’ll still have to pay income taxes on your distribution, though.)
Now let’s say that you took no salary at all. What would happen? You wouldn’t owe any employment taxes, but you’d also be breaking the IRS’ rules, as it requires S corporation shareholder-employees pay themselves a reasonable salary (at least what other businesses pay for similar services).
- Here’s a chart that displays how much you can save in Social Security and Medicare taxes when you start operating with S corporation taxation. In this example, you would take 40% of your business profit as an employee salary, and take 60% as a shareholder distribution.
Side note: If you want more in-depth information on how to determine your salary, check out The Freelancer’s Guide to Paying Yourself a Salary From an S Corporation.
2. Deduct medical expenses as a business deduction
- We already mentioned that you can deduct your health insurance costs as a personal income tax deduction to save money. But the tax benefits will be much greater if you deduct these costs as a business expense. That way, you reduce your self-employment taxes and your income taxes.
- You can deduct health insurance costs as a currently deductible business expense if your business pays them on behalf of an employee. Unfortunately, if you’re a sole proprietor, partner, LLC member, or S corp shareholder with more than 2% of the company stock, you can’t be an employee of your own business for these purposes—and that’s the vast majority of self-employed people!
This means that you can’t have your business provide you with health insurance and deduct that cost as a business expense. However, there’s a way around this limitation: hire your spouse to work in your business as your employee, and provide him or her with family medical coverage.
- Purchase the health insurance in the name of your spouse/employee, not in the employer’s name. The policy can cover your spouse, you, and your kids and other dependents. Plus, it can cover your children up to the age of 26, whether or not they’re your dependents.
Once all of this is done, you can then deduct the cost of the health insurance as a business expense. And you can also establish a health reimbursement arrangement (HRA) that lets you reimburse your spouse-employee for medical expenses other than insurance. Those reimbursements are tax-free. Pretty neat, right?
- If you’re a single parent, you could hire your child and then deduct the cost of your child’s health insurance as a business expense. The only thing is that your child’s policy can’t cover you or other family members. Bummer.
- But what if you’re single? Then you won’t be able to hire a spouse to take advantage of this strategy for turning health insurance costs into a business expense. Frustrating, we know.
Who doesn’t love saving money on taxes?
Whoa, that’s a ton of information. Feeling like your mind is blown? We don’t blame you! It’s hard to navigate taxes as a regular employee; never mind as a freelance business owner. Thankfully, by implementing the tax strategies above, and accessing support from services like Hyke, you can be a savvy freelancer, not only when it comes to the actual work that you do, but also when it comes to saving more money and using it to grow your business. We hope these tips are helpful in getting you set up for tax return success in 2019!