Self-employed people like their independence and ability to work when and where they want. But it would be best if you got smart about self-employed tax deductions.
A self-employed person runs a business. You are responsible for your income and taxes instead of a company that gives you a paycheck. The pressure to generate revenue and grow your business is on you. At the same time, you must pay federal, state, and local taxes. Knowing how to lower the overall tax bill can increase your income.
Below are ten essential tax deductions that self-employed people need to know. If you don’t take advantage of these, you may be paying more taxes than you should. Of course, you should check with a certified accountant or tax advisor.
10 Important Self-Employed Tax Deductions
According to Jorey Bernstein of Bernstein Investment Consultants: “Maximizing tax deductions is a key strategy for self-employed individuals to reduce their tax burden and keep more money in their pockets. It’s important to stay organized, keep thorough records, and consult with a tax professional to ensure you’re taking advantage of all your eligible deductions. Self-employed individuals can optimize their tax situation by harnessing the power of deductions and pave the way for greater financial success.”
Home Office Deduction
One important self-employed tax deduction is a home office. If you use part of your house or condominium for business, you may qualify to claim the associated expenses as a deduction. But you need to meet the Internal Revenue Service (IRS) requirements.
A home office must be used regularly and exclusively as the primary place of business. So, meeting a client once in your office doesn’t count. But if you regularly use a dedicated room for work, it probably qualifies as a home office.
Two options are available for the deduction: the simplified and regular methods.
The easiest is the simplified option. Take the home office’s square footage and multiply it by $5. The result is the tax deduction value.
For example, if your workspace is 100 square feet, the deduction is $500. A caveat is the maximum allowable size is 300 square feet. Although this method is more straightforward, it may result in a lower dollar value than the regular option.
The regular method requires more calculation but uses actual expenses. You must divide the home office area by the total home square footage. The percentage is used to allocate shared costs toward the tax deduction.
For example, a 300-square-foot home office in a 3,000-square-foot home equals 10%. Consequently, 10% of housing expenses can be deducted. You can write off ten percent of the mortgage or rent, security system, taxes, home insurance costs, utilities, internet, maintenance, and repairs.
One important point to remember is direct business expenses are fully deductible. This may occur if you have two internet connections, one for business and one for home. The IRS has more information on Topic No. 509, Business Use of Home.
Training and Education Expenses
Professional development training and education expenses are deductible. For example, a professional engineer taking continuing education courses for license renewal can deduct the cost. The classes, workshops, or seminars can be online or in-person.
Other potential items to expense in this category are textbooks, conferences, industry publications, supplies, and transportation.
The IRS requires the costs to be qualifying work-related expenses. Also, the training and education must improve or maintain the skills needed in your present work. So, if you are a real estate agent enrolled in yoga instructor classes, you would not qualify. More guidance is available in Topic No. 513, Work-Related Education Expenses.
If you are taking classes for a new job or degree, consider the Lifetime Learning Credit. You can receive up to a $2,000 maximum tax credit annually if you are eligible.
Health Insurance Premiums
Another self-employed tax deduction is health insurance premiums. However, it is tricky to qualify because of IRS rules. The cost of health, dental, and qualified long-term care insurance premiums can be deducted if you are not eligible for another plan.
Although it seems simple to qualify, it is not because if you can participate in a plan through another job or your spouse’s employer, you are disqualified for the health care deduction. Even if your spouse chooses not to enroll in their employer’s plan, you do not qualify.
A second requirement is your business must generate a net profit greater than the total insurance premiums.
However, if you meet the requirements, the expense for health, dental, and long-term care premiums for you, your spouse, dependents, and children up to the age of 27 are a personal deduction instead of a business expense. Consequently, you claim it as an itemized deduction in Schedule A instead of Schedule C.
Importantly, if you are still self-employed when you start taking Medicare, the premiums for Part B and D, supplemental policies, and Medicare Advantage are deductible.
Since the topic is complicated, referring to IRS Publication 535, Business Expenses, may be helpful.
Cell Phone and Internet Expenses
A cell phone and internet services are a more straightforward self-employed tax deduction. Almost all people operating a business need phone and internet service. The bill for a dedicated business or cell phone service is fully deductible. But if the cell phone or internet service is necessary for business and personal use, you can expense the proportion used for business.
However, one caveat is you cannot deduct basic local telephone service expenses even if you have a home office.
Another simple deduction for self-employed people is office supplies. These are mundane items required daily to operate your business, like pens, paper, postage, printer ink, post-it notes, notebooks, staples, paperclips, folders, etc.
The IRS requires taking the expense in the year an office supply was used. However, if you maintain a stock of office supplies and do not inventory them, they are deductible in the year purchased.
The Internal Revenue Service permits a deduction for larger items in the year they are bought, provided the useful life is one year or less. If the useful life is over one year, an item must be depreciated to recover the cost.
Professional Organization Dues and Memberships
We are reminded by Caleb Vering of Farnam Financial that “dues for professional organizations can be deducted.” The IRS distinguishes between clubs for entertainment and those not for that purpose. Specifically, the guidance indicates you cannot deduct membership dues or fees of clubs “organized for business, pleasure, recreation, or any other social purpose.” For example, your country or golf club fees cannot be expensed.
On the other hand, the IRS makes an exception for professional organizations like boards of trade, business leagues, chambers of commerce, civic or public organizations, bar and medical associations, real estate boards, and trade associations.
Advertising and Marketing Deduction
Yet another simple and often overlooked self-employed tax deduction is advertising and marketing expenses. Online social media or search engine ads, billboards, sponsored content on websites, TV or radio commercials, e-mail marketing, networking events, print ads, and mail fliers are all deductible.
The IRS usually allows expensing advertising “to keep your name before the public if it relates to business you reasonably expect to gain in the future…” However, some exceptions exist, like lobbying or when related to a political party or candidate.
This deduction is reported on Schedule C.
Business Insurance Premiums
Most businesses insure themselves, even if they are self-employed or sole proprietors. The insurance premiums are typically tax deductible in the year they were paid. Insurance to cover items like fire, business vehicles, liability, employee accidents, etc., are deductible. You would report the cost on Schedule C.
Many self-employed people rely on independent contractors to complete specialized or extra work. For instance, a blogger may hire an SEO specialist to improve their website. In another example, a landscaper may hire a graphic designer to create a logo for his business card.
As a self-employed person, the amount you pay the contractor qualifies as a tax deduction. However, remember if you pay someone more than $600 annually, you must file a 1099-MISC. But if you compensate a person by credit card or PayPal, the processing company or PayPal must file a 1099-K.
A vital tax write-off for a self-employed person is a retirement plan. A sole proprietor without employees can leverage an individual or solo 401(k). If you have employees, the SIMPLE (Savings Incentive Match Plan for Employees) and SEP (Simplified Employee Pension) IRAs are alternatives. Contributions to these retirement plans lower the present tax bill allowing you to build tax-deferred capital gains.
An individual 401(k) is attractive if you have no employees. Participants can contribute as an employer and employee. At most, the total contributions can be $66,000 in 2023 or 100% of earned income, whichever is smaller. Those over 50 years old get another $7,500 in catch-up contributions. The distributions are taxed when withdrawn after the age of 59-1/2.
Discussing your options with a certified financial advisor or asset manager offering these types of plans is best.
The above ten self-employed tax deductions are common but not the only ones. Depending on your business, things like meals, travel, business vehicles, interest, mileage, commissions, equipment rental, furniture, licenses and permits, processing fees, etc., may be tax deductible.
We have provided basic information, but using a professional accountant may be prudent if you need clarification on your tax return.