Being your own boss can be great. You make your own decisions, blaze your own trail, and receive self-employed tax deductions! But, in exchange for that, you must navigate the complexities of running a business. Whether you are a sole proprietor, single-member LLC, partnership, independent contractor, or freelancer, you’re running a business. That means you wear multiple hats and have daily tasks outside of doing that thing you love.
A commonality with all self-employed folks? They don’t want to pay more tax than they need to. Period.
As a self-employed person, you deserve all the tax deductions you are entitled to. There are several valuable tax deductions to be aware of. From conducting business from your home office to saving money for future wealth, here are 7 self-employed tax deductions that can result in less money paid to Uncle Sam!
Self-employment tax typically surprises people. When you work at an employer, you and your employer pay Social Security Tax and Medicare Tax (FICA) which totals 7.65%. Social Security tax is 6.2% of wages, and Medicare tax is 1.45% of wages. When you are self-employed, you pay both parts or 15.3%! This is what’s known as self-employment taxes.
The good news? You get to deduct the employer equivalent part of your self-employment tax.
Important note: Social security tax is paid on the first $142,800 of wages.
One of the biggest advantages of being self-employed is the optionality of choosing a retirement account. These accounts serve two purposes — reduce tax and invest for the future. I don’t really like the term retirement. For many self-employed folks and with today’s technology, you may never retire! So let’s call it wealth savings that can make work optional one day.
You get to choose which retirement plan works for you and your financial situation. Here are a few of the most popular accounts for the self-employed:
Traditional IRA. These accounts are available to everyone, not just the self-employed. The limits are the lowest at $6,000 a year, with an additional $1,000 catchup after age 50.
SEP IRA. Contributions are limited to 25% of net earnings from self-employment, up to $58,000. SEP IRAs don’t allow for catch-up contributions.
Solo 401k. Just like an employer 401k plan, you get the elective deferral limit of $19,500. Since you are self-employed, you are also the “employer,” meaning you could contribute an additional $38,500. The contribution limit to a solo 401(k) is up to $58,000 in 2021 ($64,500 if you’re 50 or older) or 100 percent of your earned income, whichever is less.
These accounts are a great way to reward good savers and reduce taxable income. However, keep in mind you cannot contribute more than what you earn.
Important Note: If needed, get help from a professional to determine the appropriate account and contribution for you based on income. The IRS adjusts these limits periodically.
The qualified business income deduction allows you to deduct a portion of self-employment income. Your total taxable income must be below $164,900 for single taxpayers and $329,800 for joint taxpayers to qualify for the full deduction. If you are above this, the deduction phases out.
This deduction is for “pass-through income.” Meaning income that’s reported on a personal tax return for your business. This allows eligible taxpayers to deduct up to 20% of their qualified business income. That’s a pretty good deal!
Important Note: Income from a specified service trade or business has special restrictions and subject to phaseouts.
This has become a hot topic since many professionals are working from home due to COVID. In general, this deduction is only for the self-employed. Meaning, if you are an employee, you won’t be able to utilize this deduction. However, whether you rent or own, you may deduct your workspace as a home office expense.
Your home office must be “regular and exclusive.” Meaning it’s exclusively for conducting business operations. This also applies to structures not attached to your home, like a garage or barn.
There are two methods to determine your home office deduction:
Simplified method: This is the easiest way to go. You get a set deduction, kind of like the standard deduction when filing taxes. The rate is $5 per square foot up to 300 square feet.
Regular method: This is more difficult and involves calculating the actual expenses of your home office. This is based on the percentage of your home that’s used for business. For example, deductible expenses might be your mortgage or rent, cost of utilities, and insurance.
For example, if your home office occupies 15 percent of your home, then 15 percent of your annual electricity bill can be tax-deductible.
These deductions are limited to those in your home, not office space.
One of the biggest pains of being self-employed is paying for your own health insurance. Unless you’re eligible to participate in a spouse’s employee plan. If you pay for your own insurance, you can deduct health, dental, and qualified long-term care insurance premiums.
Important note: If you are eligible to enroll in another employer’s health insurance plan or your spouse’s, the deduction will not be available. Even if you didn’t participate in that coverage.
Expenses that maintain or improve knowledge and skills associated with your self-employed business are deductible. This includes tuition, books, supplies, lab fees, and other expenses related to improving your education.
If you are learning something new outside your business scope, those expenses aren’t deductible.
This deduction could throw a red flag up to the IRS if not done within reason. Not to scare you away from using it, but don’t use travel expenses excessively. Be sure to keep good records and receipts for travel.
For business travel to qualify as a tax deduction, it must require you to spend at least one night away from home and be there to conduct business. These are client meetings, business meetings, or conferences to gain skills or knowledge for your business.
Expenses that are deductible during travel include airfare, rideshare, lodging, and meals. Keep your costs reasonable since you are still paying for them. Outlandish expenses only cut into the profitability of your business, and a deduction only cushions a part of the overall cost.
The recent Taxpayer Certainty and Disaster Relief Act of 2020 now allows a 100% deduction for meals. This applies to 2021 and 2022. Previously meals only received a 50% deduction.
Important note: If you combine business and pleasure, make sure you only deduct the part of your trip that is actually for business.
Taxes are complex. Running your business at peak performance requires keeping expenses within reason and finding every deduction you deserve. To help navigate these complexities, it’s always wise to have a good financial team on your side, like a CPA and CERTIFIED FINANCIAL PLANNER™. This list of self-employed tax deductions doesn’t cover every deduction but will give you a good start. If you want to optimize your self-employment business or strategize a financial plan to run your business at peak performance, let’s chat.