How to Reduce Self-Employment Tax: Legal Tax Avoidance Strategies for Business Owners

Introduction: The Tax Every Entrepreneur Feels First

Self-employment tax is one of the most aggressive—and misunderstood—parts of the tax code for business owners. If you’re a sole proprietor, freelancer, or LLC owner taxed as a disregarded entity, you’re paying 15.3% on every dollar of profit before you even touch income tax.

And unlike employees, there’s no employer to split the bill.

But here’s the good news: self-employment tax can be reduced, restructured, or even legally avoided using proven strategies that align with IRS rules. You just need to know which levers to pull—and when to pull them.

This blog walks through what self-employment tax is, who it affects, and the exact steps business owners can take to legally reduce their exposure and keep more of what they earn.

Want to explore entity planning deeper? Check out our blog on S-Corps and Audit Risk to learn when to switch structures for maximum savings.

What Is Self-Employment Tax?

Self-employment tax covers Social Security (12.4%) and Medicare (2.9%)—a total of 15.3% on net business income.

If you were a W-2 employee, your employer would cover half of that. But as a self-employed individual, you pay the entire amount yourself.

Who Pays It?

• Sole proprietors

• Single-member LLCs

• General partners

• Anyone who earns net profit from self-employment over $400/year

  
  

The more you earn, the more it adds up.

Example: You net $100,000 as a sole proprietor. You’ll owe $15,300 in self-employment tax, plus federal and state income tax.

The Strategy: How to Reduce or Avoid Self-Employment Tax (Legally)

Reducing self-employment tax is about two things:

• Structuring your business properly

• Maximizing deductions and strategic compensation

  
  

Let’s walk through the most effective strategies.

1. Elect S-Corporation Status

This is the #1 way successful business owners reduce self-employment tax.

When your business is taxed as an S-Corp:

• You pay yourself a reasonable salary (subject to payroll tax)

• Remaining profits are paid as distributions (not subject to self-employment tax)

Example: Your business earns $120,000 in profit. You pay yourself a $60,000 salary → pay SE tax on this portion. The other $60,000 is a distribution → not subject to SE tax.

Even after accounting for S-Corp compliance costs and payroll software, you could save thousands each year.

Read our blog on The Millionaire Parent Strategy: Paying Your Children and Funding Roth IRAs for more on setting it up properly.

2. Maximize Deductible Business Expenses

Every dollar of legitimate business expense reduces your net profit, which reduces your self-employment tax.

Commonly overlooked deductions include:

• Home office and utilities (properly calculated)

• Business mileage or vehicle use

• Business meals and travel

• Equipment and software

• Retirement plan contributions (see below)

  
  

Document everything, and keep business and personal spending separate to avoid missed deductions.

3. Hire Family Members Strategically

Paying your spouse or children (for real work) can:

• Shift income into lower tax brackets

• Create deductions for your business

• Unlock Roth IRA contributions or retirement savings

  
  

If structured right, it can even reduce overall payroll and self-employment tax exposure.

Explore this more in our blog: The Millionaire Parent Strategy: Paying Your Children and Funding Roth IRAs.

4. Fund a Solo 401(k) or SEP IRA

These retirement accounts allow you to:

• Deduct contributions from your income

• Reduce taxable business profit (and SE tax)

• Build long-term retirement savings

2025 Limits:

• Solo 401(k): Up to $70,000 total contribution (employee + employer)

• SEP IRA: Up to 25% of net business profit, capped at $70,000

This doesn’t eliminate SE tax—but it reduces taxable profit, which reduces the SE tax amount owed.

5. Split Income with an LLC Partnership

If you own an LLC with a spouse or partner, income can be strategically divided to:

• Lower individual SE tax exposure

• Optimize standard deductions

• Spread income across brackets

However, partnership rules are complex—get professional guidance before executing.

6. Consider Rental or Passive Income Streams

Income from rental real estate, capital gains, interest, and dividends is not subject to self-employment tax.

Building income outside of active operations allows you to:

• Diversify income sources

• Reduce reliance on SE-taxable income

• Take advantage of long-term tax-favored assets

Just be cautious—passive income has its own set of tax rules and limitations (see our blog on Passive Activity Loss Rules for more).

Common Mistakes That Increase SE Tax Liability

• Not switching to an S-Corp when income grows

• Failing to track deductions or using poor bookkeeping

• Overpaying self-employment tax on non-business income

• Mixing personal and business expenses, triggering IRS scrutiny

• Skipping quarterly estimated payments and incurring penalties

The biggest mistake? Waiting until tax time to do your planning. Self-employment tax strategy happens all year.

When to Make the S-Corp Move

Generally, if your net profit is above $50,000, it’s time to run the numbers on S-Corp status. The tax savings usually outweigh the setup and maintenance costs.

Talk to your CPA or tax strategist before making the switch—but don’t wait too long. Timing matters.

Conclusion: You’re the Employer Now—Act Like It

Self-employment tax can feel like a punishment for owning your own business. But the truth is: the tax code gives you tools to reduce the burden—you just have to use them.

With smart structuring, proactive planning, and a focus on what the IRS actually allows, you can reduce your self-employment tax and reinvest those savings into your growth, your retirement, or your family’s future.

Want to go deeper into entity structuring, family payroll, or multi-year planning? Read our blog series on S-Corps, HSAs, and Estate Planning Strategies to Avoid Estate Tax for a full wealth-building roadmap.