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In the Tax Deal: New Savings for the Self-Employed

The payroll tax cut in the tax bill passed by Congress last night will put as much as $2,000 back in the pockets of entrepreneurs and the self-employed next year. But what they choose to do with that money may be very different than how it’s spent by rank-and-file employees.

Unlike employees, who split the Social Security tax with their employers, the self-employed pay full freight: 12.4% on the first $106,800 of wages. That will now drop to 10.4%. Small business owners who have employees on the payroll will still have to contribute the same amount for Social Security, 6.2%, for each of their employees , but they’ll save a little money on their own personal taxes. The bottom line: A little more money to pocket or invest.

To make the most out of that relatively small bonus, small business owners could use it to replace or add machinery or other equipment to their business, says Patrick Cox, chief executive at Tax Masters, a tax relief firm in Houston, and then claim the expense as a deduction. Small business owners can deduct the full price of purchased equipment, for a maximum tax break of up to $500,000 in 2010. There will be no cap on the tax break in 2011.

The tax agreement also includes a provision that will allow small business owners to write off the entire expense in one year. Current rules require taking smaller deductions year after year, based on the equipment’s depreciation. Under the new legislation, someone writing off a $10,000 purchase at a 33% tax rate will save $3,300 right away – as opposed to saving $471 per year for seven years. With the new provision, small business owners would see bigger savings right away, which they could use to cushion their coffers, increase pay for an employee, or invest in even more equipment, says Roberton Williams, a senior fellow at the Tax Policy Center. But for the business owner who anticipates a higher tax rate going forward, this one-time savings might not be worth it: Someone who gets bumped to the 35% tax rate in 2012 would save $3,471 on taxes over seven years.

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About The Tax Blog

  • The Tax Blog brings together a team of award-winning tax journalists from the Dow Jones network and around the web to examine the tax issues, changes and legislation that affect families, investors and small business owners. Our contributors include Tax Report columnist Laura Saunders (WSJ), Tax Guy columnist Bill Bischoff and senior reporter Jilian Mincer (SmartMoney.com), retirement-focused reporter Anne Tergesen (WSJ), wealth management writer Arden Dale (Dow Jones Newswires), TaxWatch columnist Eva Rosenberg and personal finance reporter Andrea Coombes (MarketWatch), and reporter Alyssa Abkowitz (SmartMoney). They’ll provide the latest news and insight, mine the tax code for tips and loopholes, and answer your questions about tricky tax situations. Contact the The Tax Blog with ideas, suggestions or tax questions at thetaxblog@dowjones.com.

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