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Posts Tagged ‘self-employment’

Tax Tip: Self-Employed Health Insurance

While the debate over health care and health insurance continues in the U.S., there is one thing we call agree on… health insurance is expensive.  If you are paying for health insurance, any tax benefits you receive will help reduce the effective cost of your coverage.

A majority of people in the U.S. receive their health insurance coverage as a tax-free employee fringe benefit.  You may contribute to the expense, but the portion your employer pays is typically tax-free to you.  In order to attain parity between an employer and someone who is self-employed, self-employed taxpayers are allowed to deduct 100% of their premiums in calculating their adjusted gross income.  While it may seem logical and fair, it was not always this way.

In order to take the deduction, you must have self-employment income equal to or greater than your health insurance premiums.  Your salary, wages, interest, dividends, pension and other income are not considered self-employment income.  Thus, the portion of insurance you are contributing to your employee benefits and premiums you are paying while unemployed do not count.  The premiums may be deductible as an itemized deduction, but they do not qualify for the self-employed health insurance deduction.

There are a couple of changes that can affect your 2010 tax liability.

  • Your health insurance premiums are treated as a deduction for calculating your net self-employment income, which will reduce the self-employment taxes you pay.  This benefit is only applicable for 2010, unless otherwise extended by Congress.
  • The IRS has determined that Medicare Part B premiums can be treated as self-employed health insurance premiums.  Thus, if you are over 65 and are having Medicare Part B premiums deducted from your Social Security check, you can deduct the premiums if you have net self-employment income greater than or equal to your Medicare Part B premiums.
  • After March 30, 2010, any premiums paid for a child who is under age 27 will qualify for the deduction.
  • After March 30, 2010, the deduction is not allowed for anyone who is eligible to participate in any subsidized health insurance plan for themselves, their spouse or dependent (i.e., you can’t deduct your portion of the premiums paid as part of a subsidized employer health plan).

If you are self-employed or have self-employed income, the self-employed health insurance deduction may help reduce the cost of maintaining health insurance coverage.  The tax savings may not make get you over the affordability hump, but if you are paying, you might as well take advantage of whatever tax breaks you can.

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Tax Tip: Self-Employment Taxes

Self-Employment taxes are Social Security and Medicare taxes.  If you are an employee, half of the taxes are withheld from your paychecks and the other half is paid by your employer.  If you are self-employed, you get to pay all of the taxes yourself.   Lucky you.

Self-employment taxes are assessed upon your net self-employment income over $400.  Without delving into all of the various types of self-employment income, it basically means being paid for your hard work and efforts.  It does not include interest income, dividends, capital gains, pensions or other investment income.  Some of the common forms of self-employed income include:

  • Net earnings from a trade or business
  • Consulting and director fees
  • Tips
  • Payments for any services you provide to another person (e.g., maintenance, repairs, cleaning)
  • Pass through income from a partnership or limited liability company

A portion of your self-employed income may be reported to you on a 1099-MISC or a partnership Schedule K-1, but it’s highly likely that some self-employed income won’t be reported to you.  The income is taxable to you even if you don’t receive a 1099, Schedule K-1 or other tax reporting statement, and getting paid in cash doesn’t mean you don’t have to report the income.

Just like an employee, the tax is divided between Social Security and Medicare.  The Social Security tax portion is assessed at 12.4% on the first $106,800 of income for 2010 and 2011.  Since there is no cap on Medicare earnings, you’ll pay 2.9% on all of your self-employed income, no matter how high it goes.  The good news is that you get to deduct half of the self-employment tax in computing your adjusted gross income.  The bad news is that if you’re married, you and your spouse are subject to the tax separately.

There is one taxpayer favorable provision that you want to take advantage of in 2010.  For this year only, you can deduct your self-employed health insurance premiums in determining your net self-employed income.  It’s a one-year benefit, unless Congress decides to extend it.

Special rules can apply to farmers, real estate professionals, ministers, and investors.  It can get complex rather quickly, and the myriad of potential issues are beyond the scope of this article.  If you have questions or wonder if certain income is subject to self-employment taxes or exempt, you should consult a tax professional. 

With an effective tax rate that can be over 15%, self-employment taxes add up quickly.  Better to get it right, than be surprised with an unexpected tax bill later.

Social Security Reform: Increase Taxes

One of the easiest solutions to help resolve the financial crisis of Social Security  is to raise the tax rate.  The rate has been raised four times in the past 75 years.  It started at 2.0% in 1935 and is currently at 12.4%.  Although often lumped together, Medicare taxes are assessed separately from Social Security.  The Medicare tax rate is currently 2.9%.  Combined you pay 15.3% of your earnings in Social Security and Medicare taxes, before any income taxes.

If you’re self-employed, you know that you pay the entire 15.3% tax.  If you are an employee, you pay half of the tax, and technically your employer pays the other half.  Although you don’t see it, trust me when I say that you’re paying it.  How?  Because employers include payroll taxes and benefits into the cost of each employee, which determines how much you get paid.  Said another way, if your employer wasn’t paying half of your Social Security taxes, they could pay you more.

The separate assessment of Social Security and Medicare taxes started on January 1, 1994 when the wage cap on Medicare taxes was removed.  For 2010, you will pay Social Security taxes on the first $106,800 you earn, but you will pay Medicare taxes on all of your earnings, no matter the amount.

One option for increasing Social Security tax revenues is to eliminate the wage cap.  The rate doesn’t change, but the amount of income subject to tax increases.  Some people consider the Social Security wage cap to be a regressive provision.  Thus, eliminating the cap would make Social Security taxes more progressive.

One challenge with this approach is that benefits are calculated based upon the taxes paid in.  If someone continues pays more into the system, they will be entitled to draw more out.  Congress can change the rules to be whatever they want.  However, eliminating the wage cap for paying taxes, but retaining the cap for receiving benefits is a fundamental change to the system and contrary to any other pension benefit calculation.

The other option is simply to raise the rate above 12.4%. This is the solution previous Congresses and presidents have used to solve prior solvency issues.  Each time they raise the rates, they promise the new rate will fix the Social Security problem for decades to come.  When President Carter signed legislation in 1977 that raised the Social Security and Medicare rate to 12.3%, he declared it would make Social Security sound until 2030.  It didn’t happen.  Additional reforms were needed in the 1980’s and 1990’s.  We’re still 20 years shy of 2030, and Social Security is facing a looming solvency issue.

Increasing taxes may need to part of the solution in reforming Social Security, but it should not be the first and only thing that is done.  Like other budgetary issues, there is an income and expense part of the equation.  It’s foolish to only look at one half when you’re trying to solve a problem.  For too long, we have tried keep Social Security sound by pumping more money into the system, but it hasn’t worked. 

Increasing Social Security taxes hasn’t fixed the problem in the past 40 years, and it won’t fix it now.  It’s time to take a new approach and reform the system of benefits, and then determine if additional revenue is needed.