Whack your self-employment tax

For businesses in Hyannis, Centerville, Provincetown or anywhere on Cape Cod, one of the most deadly killers of small sole-proprietorships that I have seen is the Self-Employment tax. It is the equivalent of the FICA (AKA Social Security) tax that is deducted on an employee’s paycheck. But the rate for the Self-Employment tax is twice that of FICA. And since a sole proprietor does not receive a regular paycheck, the pain is not spread out in easy to digest small time periods. Sole Proprietors must send quarterly checks directly to the IRS, often in very large amounts. If they get behind—something that often happens—they can find themselves facing crippling tax bills at tax preparation time in April.

There are some strategies available to (a) provide for paying the tax by carefully setting aside funds, or (b) reduce the tax through the use of special tax breaks.

One tax provision that often works well for the reduction of Self-Employment tax (depending on the type of business and its own particular circumstances) is known as the Section 179 expense option. This allows a business that purchases a large item of machinery or equipment to write off, in many cases, the entire purchase price of the equipment in the year of purchase. This can be done even if the equipment is financed with a multi-year loan. The result can be that the business’s profit is partly or completely eliminated for tax purposes, the sole proprietor pays little or no tax, and he still has cash he needs to operate and to live.

This strategy can be a trap in itself if it is not done carefully. You can’t buy a big piece of equipment with a big loan attached unless you actually need it and it will actually enable you to make more profits in the future. Over-use of this strategy can get you into a situation in which you are over-expanded, have equipment you can’t use and you can’t make the loan payments.

However, there are many cases in which this strategy makes sense, and for 2010 and 2011, this tax break has been expanded to help stimulate the economy.

For the many construction and landscaping contractors on the Cape, medium-duty or heavy vehicles are often much needed, and they can often qualify for some of these tax write-offs. Be sure to consult your tax professional before acting!