Have you become self-employed and begun working from home? If so, you need to be aware of all your legal tax deductions so you can avoid overpaying your income taxes. Here’s how tax deductions work.
According to the Census Bureau, there are more than 26 million businesses in the United States that don’t have employees. The Census Bureau calls these businesses non-employers. Some are self-employed full time. Others work part-time as gig workers or running sideline businesses.
Self-employment can be financially and personally satisfying. But one big challenge is understanding self-employment taxes and deductions. Besides keeping track of your income and expenses, you also have to set aside money to pay your self-employment taxes. Here’s some information that will help you understand self-employment taxes and tax deductions.
What are self-employment taxes?
The self-employment tax is the Social Security and Medicare taxes you owe on your self-employed income.
When you work for an employer, half of your combined Social Security and Medicare contributions (7.65%) are withheld from your paycheck. Your employer pays the other 7.65%.
When you’re self-employed and operating as a sole proprietor, you pay the entire amount yourself. You calculate the self-employment tax on your net earnings (income minus expenses) using IRS Schedule SE.
What is the Self-Employment Tax Deduction?
Because you pay the full cost of Social Security and Medicare when you’re self-employed, the IRS gives you a break on your taxes. You can deduct half of your self-employment tax from your adjusted gross income. You calculate the deduction on Schedule SE and report it on Schedule 1 (Form 1040).
What other deductions can you take?
You can deduct all ordinary and normal expenses of running your business.
How do you deduct your business expenses when you’re self-employed?
Schedule C is the tax form self-employed sole proprietors use to report income and expenses. To deduct your business expenses, you list them on Schedule C. Then you deduct the total expenses from your business income to determine your net profit or loss. You transfer that profit or loss to Form 1040 to determine your personal taxable income.
Which tax deductions are worth claiming?
The specific tax write-offs you can claim will depend on the nature of your business. But you’ll likely want to claim all the deductions you’re entitled to. Some common deductible expenses are listed below. If you’re unsure about a deduction, seek help from a tax professional.
The Home Office Deduction
Do you run your business out of your house? If you do, and you’re operating as a sole proprietor, you may qualify for a home office deduction.
The simple way to calculate the amount of your home office deduction is to measure the area you use to do your work. Multiply the square footage of your workspace by $5.00 to determine your home office deduction. The most you can claim using this simplified method is $1,500 (300 square feet).
If you use a larger area for business or think you should get a larger home office deduction, you can use an alternate, more detailed method of calculating the amount. You can get those instructions by reading IRS publication 587.
Note that the IRS stipulates your workspace needs to be used exclusively for your business to qualify.
Section 179 Deduction for Business Equipment and Property
The Section 179 deduction allows businesses to treat the purchase of certain property as an expense instead of depreciating it. That means you can deduct the cost in one year instead of depreciating it over several years.
The Section 179 deduction is sometimes referred to as the expense deduction. You take it the year you put the property into use. Thus, if you bought a new business computer on December 31, 2021, but didn’t start using it until January 3, 2022, you would take the 179 deduction on your 2022 tax return.
To take advantage of the deduction, the property has to be used more than 50 percent for your business. You can expense up to $1,050,000 in equipment for tax year 2021. That goes up to $1,080,000 for the 2022 tax year.
There’s another limit to keep in mind, too. If you spend more than $2,620,000 in eligible equipment in a year, your expense deduction gets reduced dollar for dollar.
Your expense deduction can’t be more than you net income from the business. If it is, you may be able to carry the unused part forward as a deduction on your next year’s tax return.
Section 179 can also be used to expense business vehicles, but the amount that can be expensed is limited and the rules get more complicated. You should check with your accountant to determine the best way to treat business vehicles for tax purposes.
Qualified Business Income Deduction (QBI)
The qualified business income (QBI) deduction is one that lets eligible businesses deduct up to 20% of their qualified business income on their personal return. Eligible businesses include most pass-through entities, such as sole proprietorships, partnerships, and S corporations.
The income that qualifies for the deduction is the net profit from operating the business inside the U.S. Interest, capital gains, dividends, and certain other types of income are not eligible for the deduction.
The deduction is only available to individuals with a total 2021 income (business income plus any other personal income) of no more than $164,900 for single taxpayers or $329,800 for couples filing jointly.
Not all businesses qualify. Among those that are excluded from taking the QBI are those in the fields of:
- Health
- Law
- Accounting
- Actuarial science
- Performing arts
- Consulting
- Athletics
- Financial services
- Brokerage services
- Investing and investment management
- Trading or dealing in securities, partnership interests, or commodities
- Any trade or business where the principal asset is the reputation or skill of one or more of its employees or owners, such as receiving fees for promoting or endorsing products or making appearances.
See the IRS.gov website for additional information.
Communication Costs
Communications services and devices are an integral part of your business. Thus, your Internet connection, cell phone, computer, tablet, landline phone, and other communications costs are all deductible expenses. The amount you can deduct for each communication expense depends on the percentage of time you use it for self-employment. For instance, if you use your home Internet connection half of the time for business and half of the time for personal use, you can deduct half of the cost.
Car and Truck Expense Deductions
If you use your car or truck in business you can deduct the costs. The simple way to do that is to keep track of the mileage and take the mileage deduction, which is 56 cents per mile for 2021 and 58.5 cents per mile for 2022. Alternately, you can track all the expenses associated with the vehicle and deduct that amount.
Business Travel Deductions
You may have to travel away from home to an out-of-state client, a trade show, or other business purpose. Such business travel is likely to be deductible as a self-employed expense. The expenses must be ordinary and necessary. You can’t deduct lavish or extravagant expenses.
Among the travel expenses you can deduct are hotel expenses and fares for air travel, busses, taxis, and rental cars while on your business trip. You can also deduct tolls, parking fees, and tips.
Most years you can only deduct 50% of the cost of meals while traveling. But for tax years 2021 and 2022, you can deduct 100% of the cost of business meals at restaurants. As with all deductions, be sure you keep good records. Note the purpose of the travel, who you met with, and all your expenses so you can prove your deductions.
Business Education Deductions
Educational products and courses that maintain or improve the skills you need in your business are tax deductible when you’re self-employed. For instance, if you took a course to learn how to build a website for your business or bought a book about marketing, it would be deductible. But you can’t deduct any education expenses that would train you for a new career.
Self-Employed Health Insurance Deduction
If you work for yourself and have a net profit for the year, you may be able to deduct health insurance payments you make on behalf of yourself, your spouse, and children up to age 26. This deduction is not taken on Schedule C. It doesn’t reduce your business income for self-employment taxes. Instead, it’s an “adjustment to income” on Schedule 1 of Form 1040.
To qualify, neither you nor your spouse can be eligible for coverage through some other employer. Additionally, the amount you deduct can’t exceed the profit from your business. Thus, if it’s your first year in business and you didn’t make a profit, you wouldn’t be able to deduct any health insurance costs.
Other Common Self-Employed Tax Deductions
Every business has certain products and services they need to run their business. The cost of those products and services is deductible. Depending on your business, these are some of the common deductions you may be able to take.
- Office supplies, such as copy paper, notepads, toner, and pens
- Email marking service subscription
- Website development, hosting, and maintenance
- SEO services
- Writing and editing services
- Software subscriptions
- Subscriptions to industry publications
- Advertising costs
- Graphic design costs
- Printing costs
- Photo and music licensing costs
- Remote backup services for your computer and website
- Cloud-based productivity and team management services
- Bank fees
- Interest payments on business loans and business charge cards
- Business insurance
- Legal and accounting fees
- Startup expenses
- Gifts of nominal value
- Membership in the Chamber of Commerce, trade associations, and certain other business organizations.
The items in this list are some of the more common expenses. You may have others. Keep good records (and receipts). As long as your expenses are ordinary and necessary for your line of business, they should be deductible.
The ZenBusiness Money app can help you with this task. With a few simple clicks, you can track, categorize, and manage all your expenses and small business tax deductions.
Check out IRS publication 535 for more information and consult with a tax professional to be sure you’re taking all the deductions you can. The deductions will lower your net profit, and therefore lower your self-employment and income taxes.
Do you own an LLC currently? If so, learn more about LLC self employment tax.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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