It’s the dream of millions of Americans, and one that has come true for many of us: Self-employment. Perhaps you can claim yourself among this ever-growing segment of the population, and you’re enjoying the freedom and empowerment that come with working for yourself.
However, the dream can turn into a nightmare when tax times comes around. The IRS has very specific rules in place for taxpayers who list themselves as self-employed on their tax return. That can often lead to a tax bill that can be staggering.
Luckily, there are many of tax deductions available for the self-employed to claim in an effort to reduce their tax liability. Lots of these benefits are available for expenses you’re already making during the normal day to day operation of your enterprise. Being your own boss can be great. Claiming tax write-offs, as a result, make it that much more advantageous annually.
Of course, it’s important to know specifically what you can write off and what you can’t. It will take a little bit more work to manage all of these deductions, because you’ll want to have all of your records in order. You need to support the deductions you’ve claimed on your return for the tax year.
That means keeping all of your receipts and tracking your expenses. Additionally, that requires taking impeccable notes as to where, how, and why you made certain expenses so that you may rightfully claim them.
The good news is that there are plenty of online tax software programs out there. They can help you itemize and organize all of your corresponding paperwork. In turn, you have everything at the ready in the event you face an audit.
Audits are an ever-present possibility regardless of whether or not you claim a variety of deductions. Be careful about raising any red flags with the IRS. Be sure you only take those deductions that you can realistically claim.
Taking too many deductions can also get their attention. However, never refrain from claiming what you feel you deserve and are able to back up with documentation). That way, if you are audited and you have all of the necessary paperwork to support your claims, then you have nothing to worry about.
In order to start properly managing your self-employment deductions, the first thing you need to do is secure a Tax ID Number (TIN). Once you have a TIN, you can take all of the appropriate tax deductions that you have coming to you.
It’s free to acquire a Tax ID Number. Plus, it’s a smart move for any self-employed individual to make. This is especially true when they’re required to fill out a W-9 form for a customer or client. If you are working as an independent contractor, this will most likely be a necessity for you.
Many self-employed individuals will also choose to work from the comfort of a home office. This is one of the most common tax deductions you will be able to claim on your taxes. Nonetheless, be very careful about defining and delineating where that space is located in your home and how it’s used.
You don’t necessarily need to devote an entire room to an office. You can set up shop in a corner of any room in your home — although you do have to meet some strict criteria in order to claim the full deduction of operating out of a home office setting. Don’t worry, we’ll get to all of those in just a minute.
How to Know Which Deductions to Claim
Take full advantage of every deduction you have coming to you. They best way is by knowing which ones you may be entitled to claim. That is going to rely primarily on the type of business you own. However, there are plenty of different deductions out there for all of them.
Let’s say you own a business in which you offer a specific product. In that case, you may be able to claim deductions for the expenses necessary to the production and sale of that product. That can mean any costs related to equipment, supplies, and inventory. Even storage space and shipping costs could be deductible.
Perhaps your business provides a service instead of a product, such as a consultant or financial adviser. You could potentially write-off any expenses that go toward travel, rent, and entertainment. You can also deduct renting office space, and marketing yourself to your clientele.
Do you rely on the use of a personal computer or vehicle to conduct business? Chances are you use your smartphone to stay in contact with clients at all hours of the day (and night). Guess what? You may be able to deduct the expenses associated with maintaining all of these items and more. These must be germane to the successful operation of your business when you file as self-employed.
There are more, including interest paid on loans that were taken out on your business. Additionally, tuition costs for educational courses that are directly connected to the type of business that you own and operate can be deducted. Health insurance costs are another major self-employment deduction. Yet, some business owners neglect to claim when tax time comes around.
If you are filing as self-employed, you are allowed to deduct your premium costs for medical, dental, and long-term care insurance. You may claim these “above the line”. Therefore, you can still lower your taxable income without itemizing everything you plan to deduct.
Best of all, perhaps you’re not taking the itemized deduction on your premiums. Accordingly, you won’t have to meet the 10% adjusted gross income reduction. That is what most medical costs are subject to under an employer.
In other words, it doesn’t really matter what type of business you own — you will find a whole range of applicable tax deductions. They can greatly affect how much (or how little) you’ll be required to pay as a self-employed filer.
Keeping Precise and Thorough Records
Business bank accounts and credit cards are the primary methods of payment for most self-employed individuals. There are many requirements that come with filing business taxes. Thus, these accounts usually offer ways for you to track your expenses.
You can view your annual summaries. Add up how much was spent in the appropriate categories related to your business operations. Review your monthly statements to go over all of your transactions at year’s end.
Many people also like to keep their personal and business banking separate from one another. In doing so, filing is made that much easier when the time comes. Knowing how much you spent and where will allow you to find your deductions and claim them with ease. That’s why you want to make sure you have all of this necessarily documentation available.
Putting your receipts in an envelope is the old-school way of tracking your expenses. Consequently, now, with all of the online tax software options that are available, the program does the work for you. It can track, record, and tally all of your deductible expenses.
It will alert you to any available deductions that are applicable to your type of business. It’s a lot easier than filing all of your receipts or scrolling through your online banking app to review all of your expenses throughout the year.
In whatever way you choose to do your record-keeping, be sure you do it and do it well. All of the paperwork related to your deductions should be readily accessible. You’ll need it to support your claims to the IRS.
As we’ve discussed, the number of deductions you may be able to claim will largely depend on your business. However, there are some write-offs that almost every self-employed filer could be eligible to claim. Take a look at the following. See how many of them might apply to your situation. Then, find out what requirements need to be met to deduct them from your taxes for this tax year.
Contributing to a Retirement Plan
This is a deduction that every self-employed filer wants to get in on. That is because it represents one of the best methods for getting a significant deduction on your business taxes. You have a few types of plans from which to choose. The deductions you may be able to claim can prove more lucrative than to salaried employees making the same amount of money.
The best part about it is that this deduction option is available for business owners who have employees. It’s also for those who do not.
Here are three of the most common retirement plans for the self-employed.
- A 401(k) option
- A Simplified Employee Pension IRA (SEP IRA)
- The Savings Incentive Match Plan for Employees (SIMPLE IRA).
Through a 401(k), you may contribute up to $54,000 per year for 2017 or $60,000 for those 50 years of age and older. In this instance, you are considered an employee as well as an employer. This means you can contribute different amounts to the fund for the year as per the regulations that govern each. The total amount that is deposited into the account is completely tax-deductible.
The SEP IRA has a similar way of helping you save and comparable contribution limits. $54,000 is the max or 25% of your net business income. With a SIMPLE IRA, you can make matching contributions to your employees’ retirement plans.
All of these can equal big deductions for you when you file. This is because Uncle Sam wants to help you save for the future. When it comes to getting the biggest write-offs, putting money away for your retirement is at the top of the list.
Working in a Home Office
Perhaps you’re just starting your business and running it out of your home. Maybe it’s well off the ground as a home-based enterprise. In such cases, you could be claiming many deductions on portions of your applicable business expenses. However, you’ll need to comply with the standards for criteria. Plus, be sure to fully record each expense thoroughly.
In order to claim certain deductions, you’ll need to know what the IRS allows in this category. First of all, let’s say have a gross income that exceeds all of your expenses. Thus, you are allowed to take the deductions on every expense that is part of running your business out of your home. However, it could be the other way around if your gross income is lower than the total sum of those expenses.
In that case, you may only take a deduction on the difference between that gross income and the total of your business expenses. Those would be what you’d pay if you were running the business anywhere but inside of your home. There is a way to better understand what that all means. The expenses that would qualify under this scenario include your phone lines, Internet/Wi-Fi costs. That is in addition to any other expenses that are related directly to operating your business.
You also need to be sure that wherever your home office is located, that it is only used for business-related work. If it’s a dual purpose area then you can’t really claim it as a home office. For example, if you work at your kitchen table and try to claim that as a home office you may be challenged. That is because it’s where you and your family eat meals as well.
That’s what the IRS means by a dual purpose space. It’s best to set up an area in the kitchen that is away from everything else. It must be used only for work-related activities. Then, you would be much better off should the IRS come digging into your situation. Obviously, an entire room in your home devoted to being only an office where you work is the true definition of a home office for the sake of this deduction.
You may also claim the expenses used in maintaining your home office. But be careful that you’re not lumping in the personal expenses of maintaining your home as well. So yes, that means you’ll need to delineate things like the heating and electricity bills.
Do this by dividing up how much you spend heating and lighting the area or room where your home office is located versus the rest of the house. That can be tricky but it needs to be done. Otherwise, you could be facing an audit. The bottom line is you may only deduct expenses that go toward keeping the area where you work operating and nothing else.
Many self-employed individuals rely on the use of their own automobile to operate their business. It doesn’t matter if you’re driving around town or need it to go long distances, you are able to deduct a number of automobile-related expenses as long as they are spent during normal work hours for your enterprise.
To claim these deductions, the IRS gives you a choice. You can itemize the actual expenses incurred by you for the automobile. That includes things like car payments you may be making on the vehicle, depreciation rates, registration costs, insurance premiums, licensing, repairs and maintenance, parking and toll fees. Perhaps you pay to rent a garage for the vehicle.
As for depreciation rates, the IRS limits what you can claim in that area through what are called “luxury limits”. These prevent you from taking itemized deductions on the depreciation of high-end, luxury vehicles. All of your deductions need to be considered average and necessary to deduct on your taxes.
Some taxpayers prefer this option because it allows them to recoup some of these costs over the course of the year. It requires good record-keeping and precise itemization. It better reflects those taxpayers’ spending habits when it comes to the utilization of their own vehicle.
The other option is to take the standard mileage rate that is established by the IRS. It provides the taxpayer with a blanket deduction that is meant to cover everything without an itemization. For the year 2016, the standard mileage rate was 54 cents per mile.
The IRS adjusts this rate on occasion. Therefore, it’s always good to check if that is updated before you file your return. Some taxpayers prefer this method of deduction because it’s simpler. Be aware, however, you may not claim both. If you do, you may get audited.
There is another thing to be aware of as well with deducting automobile expenses. Any vehicle over 6,000 pounds of gross weight is not governed by the luxury limits. Thus, you may be able to get a higher depreciation rate deduction or get the deduction on any lease payments for the vehicle.
More Depreciation Deductions
Automobiles aren’t the only expense you can write off for depreciation purposes. Let’s say your business requires you to purchase some form of equipment or property to operate. In such cases, you may be able to claim a deduction on the depreciation rates of those items as well.
The requirements in place to claim that deduction mandate that you own the property outright. It must be utilized or owned solely to generate income for your business. The property must also have a determined lifespan for that use. That means you are required to have a firm estimate on the length of time you expect it to continue generating an income. That useful lifespan may not be for a term of one year or less. Additionally, you are not allowed to purchase it and dispose of it in the same tax year.
If you need to make any repairs to the property, those could also be deducted as well. Though, again, the property in question may only be used for business purposes. If you are also living in that property, it will not qualify. If you are renting it out to generate an income, then that property meets the IRS standard. If you refinance your mortgage on that property, you may be able to claim a deduction there also.
Deducting Tuition or Educational Expenses
Are you taking continuing education courses? Are you enrolled in school for training that has a direct relation to your business? You may be unaware that you can deduct those expenses from your taxes. It’s not even limited to physically taking a class.
Perhaps you are enrolled in online courses. Maybe you’re just buying research books and other materials that will help your business grow. Those costs are also tax-deductible. Anything that enables you to expand your learning about your business can be deducted when you file. As usual, be sure to have all corresponding documentation to back up your claims.
Other deductions include if you subscribe to any trade publications that might support your business. If you make donations to any business organizations in the pursuit of bolstering your enterprise, they count too.
Our Final Thoughts
If you’re a self-employed individual who owns a small business, there are all kinds of deductions to look out for when you’re doing your taxes. Many of those to which you may be entitled are not always so obvious. Many filers simply neglect to claim them only because they are unaware they exist.
Many of the deductions we’ve discussed are relatively self-explanatory. Yet, the myriad of other potential write-offs is not so clear cut. You could be deducting everything from banking fees to public transportation expenses should they apply to your business.
Eating out at restaurants and entertaining clients are also tax-deductible expenses, within reason. Even the costs of advertising and promoting your business and those trips to Office Depot for office supplies may all be eligible for a tax deduction.
Since there are so many deductions out there, some taxpayers will get creative. They may get downright greedy in trying to claim everything they can. That’s whether they are allowed to or not. The best thing to do is check with the IRS before claiming any deduction of which you are unsure. Always remain compliant with IRS requirements for meeting the criteria of any deduction. Some of those can get complicated. Therefore, check first before you deduct.
Otherwise, you could be subject to an audit. Then, you’ll have to present your case in front of the IRS. If you have all of your paperwork in order, that will definitely help. Nonetheless, no amount of paperwork is going to do you much good unless you’re free and clear to claim the deduction in the first place.
Always check first. That can help you avoid a headache later on. One other thing to remember: Those regulations for compliance often change. So make sure you stay up to date, or you may be in compliance one year and out the next!