What Does It Mean to Be Self-Employed?
If you run your own business as a sole proprietor, independent contractor, or a member of a partnership, the IRS considers you self-employed. Even if you have a full-time job, any income from a side business is also classified as self-employment income. To determine if your earnings fall under this category, consider the source of your income and your level of involvement.
Understanding Self-Employment Taxes
Being self-employed comes with specific tax responsibilities, particularly self-employment tax, which covers Social Security and Medicare.
- The self-employment tax rate is 15.3% (12.4% for Social Security and 2.9% for Medicare).
- In 2025, Social Security tax applies to net earnings up to $176,100 (for 2024, it’s $168,600).
- An additional 0.9% Medicare surtax applies to income over $200,000 (single) or $250,000 (married filing jointly).
Unlike employees who have taxes withheld, self-employed individuals must make estimated tax payments throughout the year to avoid penalties and large tax bills.
Tax Planning Opportunities for Self-Employed Muslim Business Owners
Self-employed individuals have several opportunities to manage taxes and increase their savings while ensuring compliance with Islamic financial principles.
Shifting Income & Timing Income
- Shifting income to family members in a lower tax bracket can reduce overall tax liability.
- You have more flexibility in timing income recognition, allowing strategic deferrals to lower taxes.
Retirement Plans
- Establishing a qualified retirement plan (such as 401(K) plan) allows you to contribute pre-tax dollars that grow tax-deferred until withdrawal.
- If you have employees, you may also need to provide coverage for them.
- Self-employed business owners have more retirement plan options, including pension plans that can help them accumulate savings more quickly. This can be especially beneficial for those who started investing later in life, such as many doctors. However, these plans have administrative and funding costs that should be considered.
Employee Benefit Plans
- Offering cafeteria and medical benefit plans can help attract and retain employees.
- Sole proprietors may derive limited benefits, such as certain health-related deductions, under these plans.
Business Expenses & Deductions
- Ensure your business takes advantage of all eligible deductions, including start-up costs, home office expenses, and business-related travel.
- Health insurance costs for yourself, your spouse, and dependents may be tax-deductible.
- Contributions to a Health Savings Account (HSA) are deductible when paired with a high-deductible health plan.
Hobby Classification
If your business consistently reports losses, the IRS may classify it as a hobby, disallowing deductions. Ensure your business qualifies by:
- Maintaining accurate records.
- Showing a profit in at least three out of five years.
- Operating professionally with a clear intention to make a profit.
Why Choose an Advisor Specializing in Islamic Financial Planning?
An experienced advisor specialized in Islamic investing will guide you in aligning your tax strategy with your faith’s financial principles, aiming to ensure that all investment and business decisions are Shariah-compliant. Reach out today to work with a financial professional who understands the complexities of both the self-employment tax system and the ethical principles of Islamic finance.
