10 of the most common self-employment tax deductions for 2021
From long hours to variable income, self-employment can be a tough way to make a living. Having to report your own business income and expenses adds another layer of complication. Understanding the basics of what expenses you can deduct is important whether you decide to file a return on your own or hire an advisor to help guide you through it.
Here are some of the most common deductions that can help you reduce your taxable income and maximize your profits.
1. Your home office
The home office deduction allows you to deduct any portion of your home that you use regularly and exclusively for work. There are two methods of deducting home office expenses:
Simplified method: This method uses a standard deduction of $5 per square foot of home used for business, up to a maximum of 300 square feet. While it's a relatively easy way to account for such expenses, keep in mind that the 300 square-foot limit results in a maximum deduction of $1,500, says Ben Richmond, chartered accountant and US country manager (US) at accounting-software provider Xero.
Regular method: This method uses the actual expenses you incur. If you opt for the regular method, there are many types of expenses you can deduct, including physical objects such as furniture and appliances as well as utilities, insurance,maintenance and repairs. You calculate the deduction by completing Form 8829 to itemize these expenses, which makes keeping receipts very important, says Richmond.
You can deduct office supplies you use as part of your business. This deduction is separate from the home office deduction and includes things like pens, staples, etc. It also includes more expensive items such as computers and printers (these are capital assets that are not deducted as supplies but rather depreciated). As usual, you should keep receipts of anything you want to deduct.
2. Your internet and phone bills
You have the option to deduct internet and phone bills incurred while conducting business, such as while working from your home office. If you use either service for both work and personal use, you should only deduct the portion associated with your business.
"There's an overarching calculation that can be used when looking to deduct internet and phone expenses related to business use of internet/phone," says Richmond. "You need to maintain a record of your internet/phone expenses, and then deduct based on the percentage used exclusively for business purposes."
3. The self-employment tax
In addition to income tax, there is a separate tax self-employed people must pay called the self-employment tax. It covers Social Security and Medicare, and the rate is 15.3%, with 12.4% going for Social Security and 2.9% for Medicare.
However, there are several scenarios in which you won't be able to deduct health-insurance premiums. For instance, if you or your spouse were eligible to participate in an employer-sponsored plan, you can't deduct your health-insurance premiums. You must also report a profit to deduct health-insurance premiums. "If you do not have a profit, you can elect to claim the premiums on your Schedule A form instead of your Schedule C form," McGrant says.
4. Health insurance
If you are self employed and pay for your own health insurance, you may be able to deduct the cost of the premiums.. This deduction can also apply to your spouse, dependents, and any children under 27 who are on your health plan, regardless of whether you claim them on your return, says Monique McGrant, vice president at McGrant Tax & Bookkeeping.
However, there are several scenarios in which you won't be able to deduct health-insurance premiums. For instance, if you or your spouse were eligible to participate in an employer-sponsored plan, you can't deduct your health-insurance premiums. You must also report a profit to deduct health-insurance premiums. "If you do not have a profit, you can elect to claim the premiums on your Sch A form instead of your Sch C form," McGrant says.
5. The use of your car for business
If you regularly use one or more vehicles as a part of your business, you may be able to deduct the use on your tax return. There are two ways to calculate these expenses:
Standard mileage rate: This method multiplies the number of business miles driven by a flat per-mile rate that can vary from one year to the next. For tax year 2021, it went down from 57.5 cents to 56 cents per mile.
Actual expense method: This approach allows you to deduct specific costs associated with operating your business vehicle, such as gas, oil changes, tires, registration fees, insurance and depreciation. If you also use your business vehicle for personal use, you will have to calculate the portion of the operating costs that you incurred during business travel.
The method that will give you the greater deduction depends on your circumstances. If you have a lot of expenses to cover, the actual expense method may be better. But if your ongoing costs to operate your vehicle are relatively low, the standard mileage rate may be preferable.
Whichever method you use, if you lease your business vehicle, you must continue to use that expense method for the duration of the lease. On the other hand, if you own your vehicle, you aren't required to use the same reporting method every year.
6. Business travel
If you travel for business, you may be able to deduct the expenses you incur on your trip. "Generally travel from one business location to another is deductible as well as any travel (plane, train or automobile) to business conventions, client meetings or prospective client pitches," says Jim Daniels, a CPA at UHY Advisors.
However, that doesn't mean every expense during a business trip is deductible. For example, if you fly to a tech conference in Las Vegas, you can deduct your flight and admission to the conference, but not the trip you decided to take to the Grand Canyon on your own.
7. Continuing education and training expenses
You may be able to deduct the cost of ongoing education and training expenses if they are relevant to your business, says McGrant. "During the pandemic, self-employed people use the time to learn more about their businesses by taking additional classes online or enrolling in a program."
But if the pandemic has made you consider switching careers, you can't deduct training that trains you for a new career. In addition, "the classes must be work-related education expenses during the year to qualify. You cannot write off a class you enrolled in for pottery if your business is graphic design," McGrant says.
However, she points out that if you are eligible, there are several expenses that can be deducted, meaning not just the fee for the course itself. "If eligible, you may be able to deduct such expenses as tuition, books, supplies, fees, and transportation costs."
8. Interest paid on your credit cards and loans
Interest payments are considered tax-deductible if the line of credit helped finance a purchase for your business. "Interest expense that is related to a freelancer's trade or business should be fully deductible," says Daniels. "This does not include any interest related to personal expenditures or investments."
Daniels suggests keeping separate credit cards or lines of credit in order to keep personal and business expenses separate. This makes it easier to avoid confusing personal expenses with business expenses.
9. Retirement savings
If you are self-employed, there are several types of retirement plans on which you can deduct contributions. These plans are specific to self-employed people and business owners, and deducting your contributions allows you to reduce your taxable income.
"One of my favorite ways to advise clients to save on taxes is to contribute to a retirement plan," says Kristen Keats, Founder and CEO, Breakaway Bookkeeping + Advising. "Paying your future self sure beats paying the IRS and state agencies' taxes on the full amount of your hard-earned profits."
Simplified Employee Pension (SEP) IRA
Deducting SEP IRA contributions is one of the most convenient ways for self-employed people to reduce their taxable income. Self-employed people can contribute up to 20% of net earnings, and that contribution is fully tax-deductible. Self-employment tax is calculated before SEP contributions. Thus, these contributions do not affect self-employment tax.
As its name implies, the SIMPLE IRA is an easy option for small business owners, and deducting your contributions can also lower your taxable income. SIMPLE IRA contributions are fully tax-deductible. "Under a SIMPLE IRA, you have to have fewer than 100 employees and the employees have to receive at least $5,000 of compensation in the prior calendar year," says Keats.
While the SIMPLE IRA has some prerequisites, it does come with advantages. "They do not have to meet the non-discrimination requirements, minimum participation and minimum coverage rules, vesting rules or other top-heavy rules applicable to other qualified plans such as a 401(k)," says Keats.
However, Keats notes that these plans come with contribution limits lower than the 401(k), capped at $13,500 with an additional $3,000 for employees 50 and older.
A solo 401(k) is only an option if you have no employees other than your spouse. "Just like a regular 401(k), you can make contributions as an employee up to $19,500 in 2021 (owners 50 years and older get an additional $6,500), and as the `employer' you can make an additional contribution up to 25% of net earnings for a combined maximum contribution of $58,000 (similar to the SEP option)," says Keats.
Employer contributions to solo 401(k) plans are fully tax-deductible, while employee contributions can either be deferred or can be contributed to a Roth solo 401(k).
10. Business Meals
Meals are tax-deductible when they are business-related, such as when attending a business conference or meeting with a client. However, you can't deduct expenses for your family member or friend who is in attendance unless they work for you. Plus, meals can't be extravagant; they don't have to be at the cheapest restaurant around, but it should be within reason.
Additionally, your business meals must be separate from entertainment since the passing of the Tax Cuts and Jobs Act. If you eat at a place of entertainment that is not exclusively a restaurant, you must be able to separate meal expenses from entertainment expenses on receipts.
Lastly, business meals are 100% deductible in 2021, notes Gary Watts, certified tax planner at Frontier Wealth Strategies, LP. In the past, these expenses were only 50% deductible. However, the 100% rate is temporary and expires at the end of 2022.
The financial takeaway
While doing business can be costly, knowing what is and isn't deductible and maintaining good records will help you keep expenses to an absolute minimum, thus bolstering your bottom line.
We've given you a small sampling of the most common tax deductions, but there are many more available. Whether you do your own taxes or meet with a tax professional, these basics will start you on the right path to understanding self-employment tax deductions.
Content from 10 of the most common self-employment tax deductions for 2021 by Bob Haegele on businessinsider.com