Through the years, legislators have added various lines to the tax code to help self-employed people cope with the additional costs of doing company. Several modifications to self-employed tax deductions were made by the Tax Cuts and Jobs Act (TCJA), which took effect for the 2018 tax year.
Small businesses are impacted by the law in a variety of ways, including a qualifying business income (QBI) deduction for pass-through enterprises—those that pay taxes as individual taxpayers rather than as a corporation. This deduction is extremely beneficial to operators of sole proprietorships, partnerships, S corporations, and certain trusts, estates, and limited liability organizations (LLCs).
Before we move forward and dive deeper into the subject of tax deductions for the self-employed, let’s first discuss the self-employment basics, starting with self-employment tax.
What is Self-Employment Tax?
Individuals who work for themselves are subject to the self-employment tax, which is made up of Social Security and Medicare levies. It’s comparable to how most wage earners’ Social Security and Medicare taxes are deducted from their salary.
Schedule SE is used to calculate self-employment tax (SE tax) (Form 1040 or 1040-SR). Most wage earners’ Social Security and Medicare taxes are calculated by their employers. Also, when calculating your adjusted gross income, you can deduct the employer-equivalent share of your SE tax. Taxes on Social Security and Medicare cannot be deducted by wage workers.
Rate of Self-Employment Tax
The tax rate on self-employment is 15.3 percent. The rate is divided into two parts: 12.4 percent for social security (old-age, survivors, and disability insurance) and 2.9 percent for Medicare (hospital insurance).
For 2020, any combination of the Social Security part of self-employment tax, Social Security tax, or railroad retirement (tier 1) tax will apply to the first $137,700 of your total salary, tips, and net earnings. For 2021, the sum has been increased to $142,800.
All of your current year’s combined salaries, tips, and net profits are liable to the 2.9 percent Medicare portion of the Self-Employment tax, Social Security tax, or railroad retirement (tier 1) tax.
Do not pay the 12.4 percent social security component of the SE tax on any of your net profits if your salaries and tips are subject to either social security tax or the Tier 1 part of railroad retirement tax, or both, and total at least $137,700. However, the 2.9 percent Medicare portion of the SE tax must be paid on all of your net earnings.
Wages, compensation, and self-employment income above a threshold amount received in taxable years beginning after December 31, 2012, are subject to an extra 0.9 percent Medicare tax rate.
If you don’t utilize the calendar year as your tax year, you must apply the tax rate and maximum earnings limit that were in place at the start of your tax year. Continue to use the same tax rate and maximum earnings limit throughout your tax year, even if the rate or cap changes.
Who Must Pay Self-Employment Tax?
If either of the following applies, you must pay self-employment tax and file Schedule SE (Form 1040 or 1040-SR).
- You earned $400 or more from self-employment (excluding church employee income)
- You earned $108.28 or more as a religious employee
Self-employment tax applies to your net profits from self-employment in most cases. Schedule C is used to calculate net earnings from self-employment if you are self-employed as a sole proprietor or independent contractor.
Use Schedule SE to calculate your net earnings from self-employment if you have earnings subject to self-employment tax. You must first calculate your total earnings subject to self-employment tax before calculating your net profits.
Most Common Tax Deductions for Self-Employed
It’s crucial to remember that tax laws change all the time, and these provisions could be changed or expanded at any time before 2025. To remain updated, a review of the most prevalent self-employed tax deductions is required.
1. Tax Deduction for Self-Employment
The Medicare and Social Security taxes that self-employed people should pay are referred to as the self-employment tax. Freelancers, independent contractors, and small-business owners are all included. The self-employment tax rate is 15.3 percent, including Social Security at 12.4 percent and Medicare at 2.9 percent.
The self-employment tax is split between employers and employees. Each is responsible for 7.65 percent of the total. People who are completely self-employed are responsible for both aspects. If your income exceeds a specific threshold, you will be subject to an additional 0.9 percent Medicare tax rate.
2. Deduction for Home Office
One of the more complicated deductions is the home office deduction. In other words, you can deduct the cost of any workspace that you use frequently and solely for your business, whether you rent or own it.
You’re basically operating on the honor system, but you should be prepared to defend your deduction if an IRS audit occurs. If you are needed to submit this information to verify your deduction, which employs the square footage of your workspace in its computation, one way to do this is to draw a schematic of your workspace with correct measurements.
The business percentage of deductible mortgage interest, house depreciation, utilities, homeowners insurance, and repairs that you pay over the year are all expenditures that you can claim for your home office, in addition to the office space itself.
3. Deduction for Internet and Phone Bills
You can claim the business part of your phone, fax, and Internet expenses regardless of whether you claim the home office deduction. The trick is to only deduct expenses that are directly relevant to your business. For example, you might deduct the expenditures of maintaining a business website that is tied to the Internet.
4. Deduction for Health Insurance Premiums
You can claim all of your health, dental, and qualified long-term care (LTC) insurance premiums if you are self-employed, pay for your own health insurance, and are not eligible to join in a plan via your spouse’s work.
You can also offset premiums paid for coverage for your spouse, dependents, and children under the age of 27 at the end of the year, even if they aren’t considered dependents on your taxes.
5. Deduction for Meals
When traveling for business, attending a business conference, or treating a client, lunch is a tax-deductible business cost. Under the circumstances, the meal cannot be expensive, and you can only deduct 50% of the actual cost of the meal if you keep your receipts, or 50% of the normal meal allowance if you maintain records of the time, location, and business purpose of your journey but not your actual meal receipts. As a result, the desk lunch is not tax-deductible.
6. Deduction for Travel
Business travel must continue longer than a regular workday, require you to sleep or rest, and take place outside of your tax home’s general vicinity to qualify as a tax deduction. Usually, this happens outside the city where your business is located. Furthermore, in order for a trip to be considered a business trip, you must have a specific business purpose in mind before leaving home, and you must actually engage in business activity while on the road—such as acquiring customers, meeting and greeting clients, or gaining experience directly related to your business.
7. Deduction for Vehicle Use
When you are using your car for business, you can deduct the costs of those trips. Don’t attempt to claim personal car travels as business car trips; keep accurate records of the date, mileage, and objective of each trip.
If you’re self-employed, there are a lot of tax deductions that go unnoticed. The good news is we can help! Contact TFX today and let us show you how to take advantage of these opportunities for your company. We’ll make sure the IRS doesn’t get their hands on any money unnecessarily and provide expert advice in order to ensure compliance with all regulations.
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