The recently enacted Small Business Jobs Act of 2010 includes a wide-ranging assortment of tax changes generally affecting small business. One provision that could be valuable to business owners this year concerns the calculation of self-employment tax.

Generally, business owners can't deduct the cost of health insurance for themselves and their family members for purposes of calculating self-employment tax. The new law allows business owners to deduct health insurance costs incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.

At issue is the 15.3% tax that self-employed individuals pay on their net earnings, commonly referred to as self-employment tax. The self-employment tax rate is the sum of 12.4% for Social Security (old age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance). The Social Security tax applies to the first $106,800 of net earnings in 2010; there is no ceiling on the Medicare tax.

Back in 2003, small-business advocates won the first battle in this area by achieving legislation allowing self-employed individuals to deduct the cost of health insurance for income tax purposes. While this change enabled small-business owners to deduct the cost of health care from their income, that income already had been exposed to self-employment tax. Thus, the self-employed effectively paid self-employment tax on income used to purchase health care.

According to a report by the Kaiser Family Foundation, employers paid an average health insurance premium of $13,770 for family coverage in 2010. The 15.3% self-employment tax on earnings used to pay this average premium would be $2,107.

Arguing that this was money that could be used to reinvest in and grow the business, small-business advocates have pushed for legislation that would allow the self-employed to deduct their health insurance premiums on their self-employment tax as well as their income tax.

The new legislation does precisely that. For now, however, the change is limited to the 2010 tax year.

We hope this information is helpful. If you would like more details about this or any other aspect of the new legislation, please do not hesitate to contact us.