- Who Qualifies as Self-Employed?
- What is a Tax Deduction?
- List of Self-Employment Tax Deductions
- Save More on your Self-Employment Taxes
Who Qualifies as Self-Employed?Before we talk about the tax deductions you can claim as a self-employed taxpayer, let’s discuss who exactly qualifies as self-employed and how the IRS determines this. The IRS says taxpayers will generally be considered self-employed if any of the following apply:
- You own and operate a business as a sole proprietor or independent contractor
- You are a member of a partnership business
- You are in business for yourself, including a part-time business
Tax obligations for self-employed individualsEveryone in the United States owes taxes in some capacity. But depending on your income, employment status, and your state taxes , you may owe more or less than your neighbor. Self-employed taxpayers have their own set of tax obligations since they’re not considered W-2 employees and their income is not withheld by an employer. So what are your responsibilities as a self-employed taxpayer in the United States? The IRS says self-employed individuals are (generally) held to the following tax obligations:
- Annual federal tax return: Self-employed individuals are still required to file a standard annual tax return with the IRS. To file your annual tax return, use Schedule C (Form 1040) or Schedule C-EZ (Form 1040).
- Self-employment tax (SE tax): The self-employment tax is a 15.3% tax on annual net earnings. This federal tax accounts for both contributions of the FICA tax: 12.4% Social Security and 2.9% Medicare contributions. Self-employed taxpayers are responsible for paying both their portion (as the employee) and their employer’s contribution since their income is not subject to withholding. And yes, 15.3% sounds pretty intimidating at first glance, but the employer part of the self-employment tax can be deducted—we’ll show you how in a moment. To report your Social Security and Medicare taxes, use Schedule SE (Form 1040).
- Income taxes: Income taxes are imposed by both the federal government and certain state and local governments. Depending on how much income you bring in as an independent contractor, you’ll owe a certain percentage of your profit to the federal government and your home state’s government if they collect income tax.
- Estimated taxes: Since self-employed income is not withheld by an employer, many self-employed taxpayers need to pay estimated taxes throughout the year to account for their various federal and state tax obligations. Estimated taxes should be reported and paid on a quarterly basis to the IRS and state Department of Revenue (if applicable). Federal estimated tax payments generally include self-employment and income tax contributions while state estimated payments are allocated by the individual state governing organizations. In other words, some states use this system while other states do not. To find out more about your state’s tax regulations, see our state tax information hub.
- Miscellaneous taxes: In addition to self-employment and income taxes, you may also be subject to other state taxes such as sales and use tax, property tax, and capital gains tax. Not sure which taxes to plan for? You may want to consider speaking to a tax and bookkeeping professional to help you plan, budget, and strategize your tax savings.
What is a Tax Deduction?So now that you’ve determined whether or not you’re classified as self-employed, let’s review what a tax deduction is and how they can save you money on your next return. A tax deduction is one way U.S. taxpayers can reduce how much they owe in taxes for a given year. When you claim a tax deduction on your return, your taxable income is reduced by a certain amount (depending on how much the deduction is worth). This reduction in your taxable income can shift your tax liability into a lower tax bracket which generally translates to less taxes owed. Tax deductions are different from tax credits because rather than reducing the amount you can be taxed on (taxable income), tax credits lower your total tax bill dollar for dollar. In order to claim any kind of tax deduction or credit, you’ll need to file the appropriate forms and supporting documents to supplement your claim. Failing to provide this information could lead to trouble with the IRS later down the line…so don’t be tempted to file for a deduction or claim that you’re not actually eligible for.
List of Self-Employment Tax DeductionsSelf-employed taxpayers are often perceived to have a greater tax burden than other taxpayers in the United States. But with the right tax deductions and strategy in place you can effectively offset the costs of self-employment. Without further ado, let’s discuss the top 10 tax deductions for self-employed taxpayers.
1. Self-employment deductionRemember when we said part of your self-employment taxes were deductible? Here’s how it works. For taxpayers that are considered employees, their employer is generally responsible for paying a portion of their Social Security and Medicare taxes. When the employer files their annual tax return, they’re able to deduct this expense as a small business tax deduction. Since self-employed taxpayers have to pay both portions of the SE tax, they too can deduct the employer portion. The self-employment taxpayers can deduct 7.65% of the self-employment tax. This means that 92.35% of your income is subject to self-employment taxes, rather than 100%. How to claim it: The self-employment tax deduction can be claimed on your income tax return Form 1040.
2. Home officeIt’s pretty commonplace for self-employed individuals and small business owners to use part of their home to run their business. It’s convenient, cost-effective, and best of all you can wear pajamas to work. What’s more, is that a portion of the cost of your home office expenses can be deducted when you file your annual tax return. But before you start writing off expenses with reckless abandon, you should consider the limitations and eligibility requirements the IRS has in place for the home office deduction. In order to qualify for the home office deduction, the IRS says you must use the space in your home exclusively and regularly for business purposes. For example, a corner desk space in your bedroom would not be deductible, whereas a separate office space within your home would be—so long as you meet the additional requirements take advantage of this deduction. To find out if you’re eligible to claim the home office deduction, use the worksheet below. If you’ve determined that you do qualify, you might deduct these expenses:
- Mortgage interest
- Depreciation for the deducted space
1. Work-related education expensesBuilding and refining your professional skills is an important part of running your own business, and the IRS knows it! For this reason, certain educational and professional development expenses are tax deductible, as long as they meet the applicable requirements:
- The course must maintain or improve your professional skills
- The course is required to keep your status or occupation
- Form 1040 Schedule C: Profit or Loss from Business (Sole Proprietorship)
- Form 1040 Schedule C-EZ: Net Profit from Business (Sole Proprietorship)
- Form 1040 Schedule F: Profit or Loss from Farming
2. Business use of your vehicleMany self-employed taxpayers rely on a vehicle to help them run their business, but costs can really start to add up—especially if you live in a state with high gas prices. The good news: depending on how you use your vehicle, you may be able to partially or fully deduct the costs of operating your car when you file your annual tax return using the business use of a car deduction for self-employed taxpayers. Here’s what business use of a car looks like: Example 1: A handyman uses their vehicle only to transport tools and themselves to a job location. They never use their car for personal errands, just for work-related trips. In this case, the handyman may be able to deduct all costs of vehicle operation because they’re only using the vehicle for business purposes. Example 2: A marketing or creative consultant regularly uses their personal vehicle to get to and from client meetings. After they’re done meeting with their client, they use their car to go to run personal errands that aren’t related to their business operations at all. Since they’re using their vehicle for both personal and business purposes, they can only deduct the costs of operating the vehicle for business use. Now this can get tricky because they’ll have to determine how much it costs them to operate their vehicle for business purposes only and exclude any personal expenses from the equation. There are two ways this can be done: the standard mileage rate or the actual expense method.
- Standard mileage rate: The standard mileage rate is typically easier to calculate and keep track of since you only need to record the business mileage you’ve accrued over the year, rather than separate all vehicle expenses. The standard mileage rate for 2019 is $0.58 per mile, which has increased from the 2018 rate. If you claim the standard mileage deduction, you will not be able to deduct any other expenses related to operating your vehicle such as oil changes, gas, lease payments, or insurance.
1. Travel and hotelIf vehicle expenses weren’t enough to make your head spin, we’re about to throw you for a loop with business travel expenses. It’s long been a topic of discussion as to when it’s appropriate to write off business lunches, hotel rooms, and the like. But if you look at the IRS publication on business travel expenses, it’s actually somewhat clear-cut. The IRS says it best: “Travel expenses are the ordinary and necessary expenses of traveling away from home for your business, profession, or job. You can’t deduct expenses that are lavish or extravagant, or that are for personal purposes.” Let’s break this down a bit.
- Traveling away from your home: The IRS says travel expenses are deductible only if the individual is doing business outside of their “tax home” for a period that is substantially longer than a standard business day. Your tax home includes both the location of your business as well as your home residence—so you can’t deduct expenses when doing business in the place that you already live or where you regularly conduct business.
- Business travel expenses: Only certain (non-lavish) travel expenses are considered tax deductible. These expenses may include: travel between your home and business destination (airplane, train, bus, or car), taxi fares from the airport or hotel to your business destination, baggage fees, meals and lodging, dry cleaning and laundry, business calls, and gratuities paid in addition to the above deductible expenses.
2. Advertising costsGenerating leads and attention for your small business is no simple task—and sometimes it involves quite a bit of capital to get the job done. But some of these costs may be deductible thanks to the advertising costs deduction. Expenses that may classify as such can include: advertising in print and digital spaces, promotional and public relations costs (e.x. Sponsorship of an event or promotional materials), email newsletters, SEO services, and pay-per-click advertising. How to claim it: Self-employed taxpayers should use Form 1040, Schedule C to deduct advertising expenses.
3. Health insuranceFor many, paying for health insurance is one of the most challenging parts of being self-employed. In fact, according to a 2018 study by Upwork, 22% of freelancers said access to affordable healthcare was among their biggest occupational concerns. But self-employed taxpayers that have a net profit may be eligible for the self-employed health insurance deduction. Deductible expenses include premiums paid on a health insurance policy for medical care for yourself, your spouse, and your dependents. The health insurance deduction does not apply to the following expenses: burial costs, non-prescription medicines, toothpaste, toiletries, cosmetics, cosmetic surgery, or nicotine gum and patches that are non-prescription. To qualify for the health insurance deduction for self-employed taxpayers, one of the following statements must apply to you:
- You were self-employed and had a net profit that you reported on Schedule C (Form 1040), Schedule C-EZ (Form 1040), or Schedule F (Form 1040).
- You were a partner with net earnings from self-employment for the year reported on Schedule K-1 (Form 1065), box 14, code A.
- You used one of the optional methods to figure your net earnings from self-employment on Schedule SE.
- You received wages from an S corporation in which you were a shareholder of at least2% . Health insurance premiums paid or reimbursed by the S corporation are shown as wages on Form W-2.
4. Retirement planIn addition to health insurance worries, Upwork’s Freelancing in America study also found that 19% of freelancers were concerned about saving up for retirement in 2018. One drawback to self-employment is that you’re kind of on your own as far as retirement planning goes—no employer matched 401(k) or withholdings like employee-classified individuals might have access to. But, self-employed individuals that contribute to a self-employment retirement plan such as a SEP-IRA, SIMPLE IRA, or a solo 401k may be able to deduct a certain portion on their annual tax return. The amount you can deduct depends on the IRS limits on contributions, which are outlined below:
- SIMPLE IRA: Employee contributions cannot exceed $13,000 in 2019
- SEP-IRA: Contributions cannot exceed $56,000 for 2019
- Solo 401k: Contributions cannot exceed $56,000 in 2019
5. Interest on business loansIf you’ve borrowed money from a business lender to fund your startup costs or regular business expenses, you may be able to deduct the interest you pay on the loan. In order to qualify for the business loan interest deduction you must: 1) borrow from a “real” business lender, not family or friends and 2) spend your business loan. How to claim it: To claim a deduction for interest on a business loan, use Form 8990.
6. Business-related subscriptionsWe talked about how work-related education expenses are considered tax deductible in certain cases if they directly relate to an individual’s trade, remember? The same logic also applies to the business-related subscriptions and publications deduction. If you subscribe to a journal, magazine, or e-newsletter that is directly related to your business, you may be able to offset the cost of your subscription fee on your tax return. The key thing to note here is that it must be directly related to your business or industry—so, if you’re an architect with a subscription to a science or culinary magazine, the IRS would not consider this expense to be deductible. How to claim it: Self-employed taxpayers and businesses can claim this deduction on Form 1040.
Save More on Your Self-Employment TaxesFiling your taxes is undeniably complex…but when special considerations and tax deductions come into the picture, tax season stress holds a whole new meaning. The Community Tax team can help you:
- Find the most effective self-employment tax deductions
- File your taxes in compliance with IRS and state regulations
- Plan for estimated tax payments