Top 10 Self-Employed Write-Offs You Should Know When Filing Taxes
Do you enjoy the freedom that comes with being your own boss? But with great freedom comes great responsibilities. If you are self-employed, you are responsible for figuring out your own taxes. You also need to keep track of business expenses so you can claim the self-employed write-offs.
In this article, you will find out about who pays self-employment taxes and what the allowable self-employment tax deductions are.
1. Who pays self-employment tax?
Along with income taxes, every individual is required to pay self-employment taxes i.e. social security and medicare taxes. You are liable to pay self-employment tax If you are:
- Working as an independent contractor
- Small business owners
- A freelancer
- Running a part-time business
- Carrying on trade in a partnership.
The rate for calculating the tax is 12.4% for social security and 2.9% for Medicare. So the total self-employment tax is 15.3%. An employee only has to pay 7.65% and the employer will contribute the rest. But, if you are a self-employed individual you have to pay the full 15.3%.
2. What are the allowable Self-employment tax deductions?
According to the IRS, to qualify for deduction a business expense should be:
- Ordinary i.e. common, and accepted in your trade
- Necessary i.e.facilitates your trade.
Following are the top 10 self-employed write-offs.
2.1. Home office
If you use part of your home as a workspace, you are allowed to deduct the expenses to the extent of its usage. There are two ways to compute your home office deduction.
- The Regular method: In this method, you compute your deduction on the basis of your actual home office expenses.
- The simplified option: In this option, you compute home office deduction using the formula mentioned below.
Deduction using simplified method = IRS determined rate x home office square footage
Note that your home office square footage can not exceed 300 square, and the IRS determined rate is $5 per square foot. The maximum deduction you can claim by the simplified option is $1500 (5$*300). In this option depreciation and home-related itemized deductions do not qualify for the deduction.
2.2. Individual retirement plans
Another allowable deduction is the contribution you make towards your retirement plan. If you have no employees you can set up a solo 401 (k). You can contribute up to 19500 in 2020 in addition to 25% of net income.
If you employ people you can have SIMPLE (Savings Incentive Match Plan for Employees- IRA. In 2020 the contribution limit is 13500 with an additional 3000 if you are over 50 years.
Another option is the Simplified Employee Pension IRA. In 2020 the employer can either contribute 25% of income Or 57000 whichever is lesser.
This deduction will reduce your tax obligation now and will enable you to accumulate tax-deferred investment later. This means you will have to pay taxes once you realize these investments.
Any meal expenses related to business incurred after Dec 31 2020 and till the end of 2022 are deductible in full. The Consolidated Appropriation Act 2021, allows 100% of meals expenses (Food and beverages) incurred for business purposes to be deducted.
2.4. Communication expenses
You are allowed to deduct the business portion of your internet, phone, and other communication expenses even if you don’t claim your home office deduction. You might have a single phone line for both business and personal purposes. In this case, you should deduct expenses to the extent it was used for business purposes.
If you have another line solely dedicated to business use then you can deduct the incurred expenses in full.
2.5. Health insurance premiums
Self-employed people who are not covered through their spouse’s employer are allowed to deduct their health expenses including Long term health Insurance premiums and dental expenses. Any health insurance premium paid for a spouse, dependent, and children below 27 years of age at the year-end is an allowable deduction.
2.6 Education expenses
Any money you spent to upgrade your skills related to your current business can be written off. For e.g. any local college course you enrolled in and books you read to enhance your business can be written off.
2.7 Automobile expenses
Your allowable deduction for car expenses is determined in 2 ways:
- Standard mileage rate: The mileage rate for 2021 prescribed by the IRS is 56 cents. This is the easiest method as it requires minimal record-keeping. You just need to know the business miles you drive and when and then multiply it by the standard mileage rate.
Total annual business mileage x standard mileage rate (56cents)
- Actual expenses. To compute the write-off using the actual expense method, first, we need to know the percentage of business-related trips. Additionally, you also need to figure out the total operating cost of the car such as repairs, depreciation, license and registration fees, etc. Let’s say if 20% of your car is used for business and your operating expense is 4000 then your deduction is 800.
If you borrowed money from a bank for your business, the interest you pay will be deductible. However, if you use it partially for personal purposes then you need to allocate the appropriate % to the interest expense and deduct it accordingly.
The interest paid on credit cards for making business-related purchases is tax-deductible.
2.9 Startup cost
You have just set up your business and your start-up cost (e.g. market research, travel cost for business, etc) is $12000. Generally, the IRS allows you to deduct up to 5000 in the first year and capitalize the remaining 7000. The IRS requires this capitalized amount to be deducted over time instead of a one-off expense.
2.10. Business insurance
If you pay premiums for credit, fire, or business car insurance you can write it off.
Do remember to keep track of the business expenses so that you don’t miss out on any self-employed write-offs that could save money on taxes. And consult with a tax expert to figure out which deductions you are eligible for.