Working for yourself offers unparalleled freedom. You can set your hours and you have the potential to earn far more for yourself than you could working for someone else. However, self-employment does have its downsides.
At Cook Martin Poulson, we work with clients who are self-employed all the time. One of the questions we hear most frequently is:
What self-employment tax deductions should I take?
We are always happy to answer questions about tax deductions. People who work for themselves often miss important deductions and pay more in taxes than they need to. We have created this guide to self-employment tax deductions to help you take advantage of every tax credit that is available to you.
Who is Self Employed?
Let's begin with the definition of self-employment. According to the Internal Revenue Service, a person is self-employed if they:
- Carry on a business or work trade as an independent contractor or a sole proprietor
- Are a member of a partnership that operates as a business
- Are otherwise in business for themselves on a full-time or part-time basis
You may need to pay a self-employment tax if you own your own business even if you operate it only part-time. If you’re unsure whether you are self-employed, you may want to consult with a professional accountant to review your tax obligations.
How Do Tax Deductions Work When You Work for Yourself?
When you work for an outside employer, tax deductions are typically much more straightforward and more limited. However, when it comes to business tax deductions, many self-employed people struggle to wrap their heads around what tax deductions are available to them.
Individuals working as an employee are only responsible for 50% of these taxes (which are withheld from their paycheck), and the other half of these taxes are paid by the employer. When you work for yourself (as a sole proprietor or in partnership), you must pay 100% of your Social Security and Medicare taxes. This is what is referred to as self-employment tax.
Before you file your taxes, you must understand the self-employment tax deduction as well as other deductions that can help you save money on your taxes.
Tax Deductions for Self-Employed People
You should be keeping track of all the money you spend for business-related purposes, whether you're operating as a freelancer, a contract worker, or you own a company as a sole proprietor or partner. By knowing what is tax-deductible, self-employed people can be sure they're not overpaying on their taxes. It is recommended that you run all of your business income and expenses through a bank account that is dedicated for the business. This simplifies record keeping and can help you avoid comingling personal and business expenditures.
As you might expect, there are multiple tax deductions for self-employed people. Below are the potential tax write-offs for self-employed individuals.
1. Self-Employment Tax Deduction
People who work for themselves are required to pay both the employer and the employee portions of the Social Security and Medicare taxes. You may be wondering what portion of the self-employment tax is deductible. The answer is simple: you can deduct the employer portion of these taxes when you file.
The current tax rate for self-employment taxes is 15.3% unless you are over the social security wage base limit ($137,700 for 2020 and $142,800 for 2021). For any self-employment income you have above the social security wage base you are only subject to medicare taxes (2.9%). The good news is that you get an income tax deduction for half of your self-employment. You should also be aware that you pay self-employment taxes on only 92.35% of your net business income.
You can calculate your deduction by using Schedule SE if you file a 1040 or 1040-SR.
2. Self-Employed Health Insurance Deduction
You can deduct the cost of health insurance when you file your taxes. If you have purchased insurance for yourself -- meaning you are not covered on your spouse's plan or a parent's plan -- you may use Schedule SE to calculate the deduction and take advantage of it on your return. You will need the total amount you have paid in health insurance premiums to calculate this deduction. This deduction is limited to the amount of self-employment income you have for the year.
3. Home Office Expenses
If you work from home, you may be eligible to claim a deduction for expenses related to your home office. Keep in mind that there are some restrictions -- and since the IRS tends to scrutinize home office deductions, you'll need to make sure you meet the requirements and don't overstate your home office expenses.
You may take the home office deduction if you maintain a dedicated space in your home where you work (this space must be business-use only, not mixed personal and business use). The amount of the deduction may be calculated using the square footage of the space. If you have a home with 1,500 square feet of living space and a 10' by 10' office, you may deduct a proportional amount of your rent or mortgage.
You can choose from the standard method, which requires you to allocate your actual expenses to the home office based on square fottage, or the simplified option, which uses a flat $5 per square foot, up to a maximum of 300 square feet. In addition to a percentage of your rent or mortgage, you may also be able to deduct a percentage of your homeowner's insurance, utilities, property taxes, and maintenance costs.
4. Internet and Phone Bills
We already mentioned utility bills, but if you work from home -- even if you don't have a dedicated office space -- you can deduct some of your internet and phone expenses.
Unless you have a dedicated phone that you use only for business purposes, you may deduct a portion of your phone bill. The same is true for your internet service. If you have unlimited data, then you'll need to calculate a reasonable percentage and keep this documented in your files in case your tax return gets audited.
5. Car Expenses
Do you use your car for business? If so, then you can deduct a portion of your car-related expenses on your tax return. These expenses may include:
- Maintenance costs
You have two options. The first is to use the standard mileage deduction which is $0.575 per mile as of 2020. The second is to calculate your actual expenses. For example, if you paid $5,000 in expenses and used your car for business 12% of the time, you could take a $600 deduction. If you use the actual expense method for a vehicle you cannot later change to basing the deduction on the mileage.
You must keep a mileage log, documenting the date, the odometer reading (or mileage), the destination, and the business purpose of the mileage.
6. Business Travel
Expenses related to business travel may be deductible. The requirements include:
- Your business must take you away from home -- meaning out of your home city -- and last longer than a workday, requiring you to sleep or rest before returning.
- You must have a planned business purpose for the trip.
- You may deduct airfare, transportation at your destination (rental car, Uber, etc.), lodging, and meals.
This means that you may not claim a trip as a business expense if you engage in impromptu business while traveling for personal reasons.
7. Business Meals
Business meals are deductible if you eat them in two circumstances:
- While you are traveling for business, as noted above; or
- While you are conducting business
You may use either the standard per-diem meal allowance (if you are out of town), or your actual meal expenses. Either way, the maximum you may deduct is 50% (unless your business falls under the Department of Transportation, which case you can deduct 80% of eligible meal expenses). It's important to note that regular meals that you eat in your home office are generally not tax-deductible. However, if you are ordering in food for an employee training meeting or a celebration event, such as a holiday, those meal costs may be 100% tax-deductible.
8. Self-Employed Retirement Plan Deductions
Another one of the big deductions for self-employed taxpayers is for retirement plans. As of 2020, you may contribute up to $19,500 of your income to a retirement plan and deduct what you contribute. You may also make an employer contribution on your behalf up to a maximum of $58,000. People over 50 may also make additional “catch-up contributions”.
Of course, you can only take advantage of these large contribution amounts if you have enough self-employment earnings to make the contributions. A qualified tax accountant can help you set up a retirement plan so, as a self-employed person, you can take full advantage of the tax deduction.
9. Interest on Loans and Bank Fees
While there are arguments for and against borrowing money for your business, many self-employed people do borrow money to pay for equipment and other business expenses. If you have taken out a business loan, you can deduct the interest as part of your self-employment tax deductions.
The same is true for interest accrued on business credit cards. Provided that the card is used only for business expenses, you may include it as part of your deductions.
10. Deduction for Education Expenses and Continuing Education
Many people who work for themselves invest in their businesses by taking classes to learn new skills. In some fields, you may be required to meet continuing education requirements.
Either way, educational expenses may be eligible for a tax deduction. Self-employed people may not deduct educational expenses related to learning a new line of work. To be eligible, these educational expenses must be related to maintaining or improving your skills for your existing business.
11. Business Insurance and Licenses
In some industries, you must pay for professional liability insurance. If you rent an office, you may need other types of insurance as well, including fire, credit, or car insurance. The premiums you pay for the business-related coverage may be tax deductible.
The same is true for business licenses and certifications. If your state requires you to carry a business license, the expenses related to obtaining and renewing it are deductible.
Life insurance premiums are typically not tax-deductible, but if you pay these, you should discuss the life insurance premiums with a tax professional to determine whether or not they are tax-deductible in your situation.
12. Publications and Subscriptions
As a business owner, you may subscribe to newspapers, magazines, newsletters, and online resources to keep abreast of news that may affect your business. You may also subscribe to web-based business software or pay for a professional LinkedIn account.
The expenses associated with these publications and subscriptions are business expenses and as such, they may be included as a self-employed tax deduction.
13. Start-up Costs
It is common for the Internal Revenue Service to require major expenditures to be deducted over a period of time as capital expenses. However, if you recently started a business, you could deduct up to $5,000 in related expenses, including market research, business travel, attorney's fees, and accounting fees.
If you incorporated your business, then you may also be able to deduct incorporation filing fees and related expenses up to $5,000.
15. Advertising and Promotion
The money you pay to advertise and promote your business is also tax-deductible. Whether you pay for printed marketing materials, online advertisements, or some combination of the two, you may deduct those expenses when you file your taxes.
Keep in mind that you may also deduct the expense of setting up a website, including the cost of purchasing a domain name and hiring a designer.
15. Contract Labor Costs
If you pay people to do work for you in the ordinary course of your business, you may be able to deduct those expenses. Here are some examples:
- Web design
- Content creation
- Virtual assistant
To deduct what you pay, you will need to provide each contract laborer with a 1099-MISC form and complete Form 1096 to show how much you paid them (for any non-corporation payee to whom you pay $600 or more throughout the course of the year).
How to Claim These Deductions
To claim the tax deductions we have listed here, you will need to keep careful track of your business expenses. You may want to use a business accounting program such as QuickBooks to help you track your expenses and monitor your tax obligations.
It is best to hire a tax accountant with experience with self-employment tax. A professional will be able to help you minimize your tax burden and save money while still meeting all IRS requirements.
Cook Martin Poulson has extensive experience with self-employment taxes. Contact us to schedule an appointment today.