Home-office deductions |Continuing education |Vehicle for business use | Health insurance | Social security taxes |
Retirement |Covid-related sick & family leave credits | Start-up costs | Equipment & supplies | Qualified business income deduction
Because of the Covid pandemic, shutdowns, remote work, and massive layoffs, many people have discovered the joys of self-employment. Even with the economy in recovery, employers are having difficulty attracting workers, and it’s easy to see why.
When you’re self-employed, you get to keep all the profits from your labor. You get the flexibility to set your own hours, and you can even make money by doing something you already enjoy.
Then again, being self-employed comes with its own set of problems. For one thing, you have to manage your own taxes. For another thing, you have to pay self-employment tax, which is an extra amount over and above what you pay in income taxes. That said, you can also take advantage of a number of self employed tax deductions. Here’s an overview of self-employment tax, along with 10 important deductions.
What Is Self-Employment Tax?
Self-employment tax is a combination of Social Security and Medicare taxes. Like your income tax, these would normally be deducted from your check automatically. But since you’re self-employed, you’ll have to settle up whenever you file your income taxes.
To pay your self-employment tax, you need to fill out Schedule SE, which you file along with Form 1040 or Form 1040-SR). Most of this tax is counted as ordinary income for income tax purposes. However, the employer-equivalent portion of the Social Security tax is deductible for income tax purposes.
What Is The Self-Employment Tax Rate
The Social Security tax rate is currently 12.4%. Normally, this amount is split between employer and employee, and is deducted from each check. But since you’re working for yourself, you pay both the employer and the employee portion of the tax. The Medicare tax rate is currently 2.9%. This works out to a total of 15.3% in self-employment tax. That said, the tax is applied differently depending on how much you earn.
The 2.9% Medicare tax is applied to all of your income, and this includes all of your wages, tips, or other money earned during your self-employment. However, the Social Security tax only applies to the first $142,800 of your income. So if you earn $150,000, the self-employment tax for the last $7,200 will only be 2.9%.
What Is A Self-Employment Tax Deduction?
As you can see, self-employment tax can already be costly. But you can end up paying even more; above a certain threshold, there’s an additional 0.9% Medicare tax. This threshold depends on your filing status:
Married filing jointly: $250,000
Married filing separately: $125,000
Head of household: $200,000
Widow or widower with dependent child: $200,000
Keep in mind that this threshold doesn’t just include your self-employment income. It also includes any wages, tips, or income you’ve earned from a regular job. So if you’re single, earn $200,000 at your day job, and make another $50,000 on your side hustle, you’ll earn $250,000. As a single person, you’ll have to pay an extra 0.9% on the last $50,000.
Nobody wants to pay more in taxes than they have to, especially when you’re essentially being taxed for the privilege of being your own boss. Thankfully, there are a number of tax deductions that self-employed individuals can take advantage of. These are typically deductions for business-related expenses or things that an employer would ordinarily provide. If you take advantage of the right deductions, you’ll find that the extra burden of self-employment taxes isn’t all that heavy.
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10 Self-Employment Tax Deductions In 2022
Whether you’re a freelancer, a contractor, or a creative artist, there are many helpful deductions that can save you a bundle when tax time rolls around. We’re about to talk about the 10 most important. These are:
Vehicle For Business Use
Social Security Taxes
Covid-Related Sick & Family Leave Credits
Equipment & Supplies
Qualified Business Income Deduction
Let’s take a closer look at all 10!
1. Home-Office Deductions
If you’re self-employed and do even some of your work from home, you might be able to get a tax deduction. After all, an employer would normally provide you with an office, so your working space is a legitimate business expense.
The important thing here is that part of your home must be used exclusively for your self-employment. So if you do graphic design, but also use your computer for gaming, your desk space isn’t going to qualify. That said, if you have a dedicated home office, or if your job requires equipment that occupies space, you can write off a portion of your rent or mortgage, or if you own your home, a depreciation write-off. You can even save money on your utilities.
Needless to say, this tax break can be a bit confusing. It’s tough to keep all the necessary records and qualify how much a given space costs. Thankfully, the IRS offers a simplified method that works well for most people. You can deduct $5 for every square foot of qualifying space, up to the maximum 300 square feet permitted by the deduction. If you can claim the maximum, you net a cool $1,500 deduction.
2. Continuing Education
If you’re running your own business, staying up to date in your field is important. Let’s say you’re a real estate agent. Real estate laws are complex, and are constantly changing. You need to take classes periodically in order to stay up to date, and you need to periodically get re-certified, which costs a fee.
Keep in mind that according to IRS Publication 970, education expenses are only deductible if the educational content “maintains or improves skills needed in your present work.” So if you’re a real estate agent, you could deduct expenses for real estate agent-related classes.
But if you’re taking night classes to become a nurse, those would not be “needed in your present work,” so they would not be tax deductible. That said, you might qualify for another benefit, like the lifetime learning credit or the American opportunity tax credit.
3. Vehicle For Business Use
Just like an office, a company might also provide a car to their employees for business purposes. If you use your car or truck in the course of your work, you can qualify for some significant deductions. Obviously, this is most useful for rideshare drivers, who can add a lot of mileage over the course of a year. But it’s also useful for anyone who has to drive to visit clients, make deliveries, or work on a remote jobsite.
The standard way to take a vehicle deduction is to use the standard mileage rate. With this method, in 2022, you can deduct 58.5 cents for every mile you drove for business purposes. Keep in mind that this doesn’t include any miles you’ve driven for personal purposes, so you’ll want to keep receipts and other records.
The other method is to use your actual expenses. You can combine all of your car-related costs, from fuel to maintenance to parking, tolls, insurance, and even your monthly payments. Then, you add up your total mileage, and calculate the percentage you drove for business reasons. Multiply that by your total costs, and you have your deduction. So if your car cost $6,000 for the year and you drove 50% of miles for your business, you could deduct $3,000.
4. Health Insurance
Health insurance is another common employee benefit, and it’s an expense you might be able to deduct from your taxes. In fact, you can deduct your premiums for both medical and dental insurance, as well as any insurance costs you’ve paid for your spouse and dependents. Long-term care insurance premiums can also be deductible under limited circumstances. As an added bonus, this is an adjustment to income, not an itemized deduction. So even if you’re not itemizing, you can still take advantage.
That said, there are a handful of limitations. To begin with, you can’t deduct your premiums if you’re eligible for coverage under your spouse’s employer plan. It doesn’t matter if their plan is more expensive; you still won’t be eligible. The deduction is also limited to premiums that exceed 7.5% of your adjusted gross income.
5. Social Security Taxes
As we already discussed, you have to pay additional taxes for Social Security and Medicare when you’re self-employed. As we also discussed, your employer would normally be responsible for half of the Social Security part of that tax. In other words, it’s a business expense, and it’s tax deductible. In total, half of the 12.4% tax, or 6.2% of your income will be deductible, and you don’t even have to itemize.
You’ll also want to keep in mind the $142,800 maximum for Social Security taxes. If you earn more than that, you won’t be paying tax on the additional income, so you won’t get a corresponding deduction for it. And if your self-employment is more of a hobby, you may not even have to pay self-employment tax at all; it only applies if you’ve earned $400 or more from your gig during the calendar year.
Your retirement savings options are limited when you’re employed by somebody else. You’re locked into whatever choices they offer, or you have to invest in an IRA with your post-tax income. On the other hand, if you’re self-employed, you can contribute to a solo 401K or a simplified employee pension (SEP). Like employer-matched plans, you’ll be able to do this on a pre-tax basis, and only pay tax when you take your money out.
Solo 401Ks and SEPs have higher contribution limits than traditional retirement funds. Individuals earning less than $34,000 can deduct a significant portion of their contributions as an added bonus. Depending on your income, you can deduct 10%, 20%, or even 50% of your retirement savings, up to a limit of $1,000.
7. Covid-Related Sick & Family Leave Credits
One major drawback of self-employment is that you don’t get a lot of the safety net programs normal employees do. For example, you don’t get paid sick time, and you don’t get unemployment insurance if forces outside your control put you out of work.
For the year 2021, at least, there’s an exception. If you were unable to work due to certain Covid-19-related reasons during the first three quarters of the year, you may be eligible for a tax credit. The exact amount of the credit will depend on your reasons for missing work, how long you were out, and other factors. The reasons include:
You were under state, federal, or local quarantine or isolation order, or you were caring for someone who was
You were awaiting the results of a Covid-19 test after an exposure
You were experiencing Covid-19 symptoms and awaiting a medical diagnosis
You were getting a Covid-19 vaccine, or assisting someone with getting one
You experienced negative side effects related to a vaccine, or you were caring for someone who did
Your healthcare provider advised you to self-quarantine, or you were caring for someone who was
You missed work to care for a child whose school or childcare facility was closed for Covid-19 related reasons
8. Start-Up Costs
Startup costs are another significant business expense. These include purchasing inventory, advertising, and other activities you perform before you start actual business operations. The total amount of the deduction can be up to $5,000, and you can also get an additional $5,000 of organizational costs. These are the costs for legally establishing your business, like the expenses involved in setting up an LLC.
Keep in mind that there’s a limit to your deduction. For every dollar your costs exceed $50,000, your deduction will be reduced by a dollar. On the plus side, startup costs are considered capital expenses. This means that they can typically be depreciated over time, and that depreciation is normally a deductible business expense.
9. Equipment & Supplies
Your home office isn’t the only office-related expense you’ll have to incur. Normally, your office will include things like pens, paper, staples, and other basic supplies. This can be done in two ways. You can either deduct everything when you buy it, or wait until you use it, and deduct it in the year it’s actually used.
More significant expenses like a computer or copier can only be deducted in a single year if their useful life is 12 months or less. If not, they’re considered assets, and they depreciate over time. You won’t be able to claim the whole value all at once, but you’ll be able to deduct it in pieces over the course of a few years.
Beyond that, you can also deduct your internet bill or cell phone bill. There’s a catch, though. If you simply use your home internet for business purposes, it won’t be deductible. You must have a dedicated business line, and you must not be getting reimbursement from your employer.
10. Qualified Business Income Deduction
The qualified business income deduction, also known as the Section 199A deduction, is one of the newer deductions. It’s made for S-corporations, LLCs, and similar pass-through entities, but sole proprietors can also take advantage.
This is a more complex tax break, with a lot of rules and regulations. Then again, it can be a significant deduction if you’re willing to go through the trouble – up to 20% of the income you’ve gained from your business. There’s a limit, though, and it starts to phase out if you earn more than $170,000, or $340,000 for married couples.
As you can see, there are many self employed tax deductions you can use to reduce your tax liability. If you want to be truly successful at being your own boss, you need to take advantage of every single deduction you’re eligible for. Otherwise, you’re leaving money on the table; and that’s just bad business.
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