Page 224 -

Sa ve Money with These Tax Stra tegies

1. Federal income,
2. Social Security,
3. Medicare, and
4. State income.

In some states, additional taxes are withheld, but for purposes of this
chapter, we will focus on these four types of withholding.

Federal income tax is withheld based on how you fill out your W-4 income
tax form for your employer. As you may know, your marital status, the number
of your dependents, and the size and extent of your itemized deductions
(mortgage interest, state and local taxes, and charitable contributions) deter-
mine your personal tax rate. Current federal individual tax rates range from
zero to 35 percent.
Currently, Social Security tax is withheld at the rate of 6.2 percent on the

first $97,500 of W-2 eligible wages, with employers contributing another
6.2 percent, for a total of 12.4 percent. If you own your own business, however,
the IRS considers you both employee and employer, and you contribute the
full amount.
Medicare tax is currently withheld from your paycheck at 1.45 percent of
your earnings and your employer pays 1.45 percent. Unlike Social Security
tax, Medicare tax isn’t capped at a certain earnings threshold; every dollar
you earn, no matter how little or how much, is subject to Medicare tax.
Like the Social Security tax, however, if you are self-employed, you must pay
the total of 2.9 percent; 1.45 percent as employer and 1.45 percent as
employee.
The combination of Social Security (12.4 percent) and Medicare taxes
(2.9 percent) are referred to as the self-employment, or Federal Insurance
Contributions Act (FICA) tax, and add up to 15.3 percent.
I stress these numbers because I know that many of you reading this book
are looking for new ways to generate income and build wealth and, often,
you’ll begin this process while maintaining a fulltime job until your new busi-
ness can begin supporting you. Yet, the extra taxes you pay to become self-
employed are a big disincentive in starting a business.
I assume that most readers are in the 25 percent federal income tax bracket,
like most working Americans. Let’s assume for the moment that you are in that
bracket, and you have just started a business. That means your self-employed
earnings will be taxed at a federal rate of 25 percent. Including self- employment
taxes, you’ll pay at least 40.3 percent. If, however, you live in some states, you’ll
pay over 50 percent because of the additional state income tax. The top fi ve

201

8/23/07 3:30:21 PM
c18.indd 201 8/23/07 3:30:21 PM
c18.indd 201