12 Tax Deductions and Benefits for Self-Employed Individuals

Are you a self-employed person, an Amazon seller or a freelancer? If any of these applies to you, keep reading for a list of tax deductions and benefits that you may qualify for.

The business structure of your self-employment business determines how you get taxed. If you are a sole owner who has not incorporated your company, you get taxed as a sole proprietor, and you are solely responsible for self-employment tax.

If you formed a Limited Liability Company (LLC) as a single owner and have not elected to be taxed as a corporation, then your business income is treated as pass-through income and is taxed at the individual level. An LLC with more than one owner is taxed like a partnership, and the LLC pass-through income flows to individual members who report it in Form 1040 Schedule C.

Now, What Are the Impacts of the New Tax Code for the Self-Employed?

The Tax Cuts and Jobs Act eliminated some business deductions. For example, the entertainment deduction was eliminated, as were the local lobbying expenses, and employees’ parking and mass transit expenses.

The new code added a complex 20% business income deduction for certain pass-through businesses. Speak with your tax accountant to find out if your self-employed trade or business qualifies for this deduction.

The costs of running a business can be so high. Therefore, understanding the deductions your business or trade is entitled to can help you minimize your tax bill and put more money into your business.

Disregarded entities, including pass-through LLCs, pay self-employment tax. Self-employment tax is the portion of the Medicare and Social Security taxes that employers would normally pay for their employees. If you are self-employed, the rate is 15.30%. In case of employment, the employer pays 7.65%, and you pay the other 7.65% through employer withholding of your wages. That being said, no one wants to pay more taxes for running their businesses, which allows them to make extra income or to find the freedom of being their own boss.

Believe me, when I see the pain on my clients’ faces while they explain to me how expensive it is to run their business, I also feel their pain! I want to help them to alleviate their situation by recommending a series of deductions they can take to lower their taxes. The following is a non-exhaustive list of some of the deductions I recommend to my business clients.

1. Self-Employed Retirement Plan Contributions

Take advantage of tax deferred deductions through SEP-IRA or SIMPLE IRA retirement accounts. As self-employed, you can make contributions for yourself and your employees. The contributions made to self-employed retirement accounts reduces your taxable income.
For the 2019 tax year, you may make salary deferred contributions up to $13,000 ($16,000 if age 50 and older). If you participate in another employer plan, the total amount of the contribution is limited to $19,000, plus 25% of the net income of your self-employed trade or business up to a maximum of $55,000. The limit changes every year, so speak with a tax accountant.

2. Health Insurance Premiums

You can deduct health insurance, dental and qualified long-term care insurance premiums as business expenses for yourself, your spouse, your dependents, and anyone else you hire. You are eligible for this deduction if you are not participating in another health insurance plan either through your employer or spouse’s employer and you have income from your trade or business. Your deduction is limited to the income of your business.

Partners and LLC members who elect to be taxed at the individual level are considered self-employed. If you fit under this category and directly pay your own health insurance premiums, you can take a deduction from your business net income. This reduces your taxable income and the amount of taxes you pay.

Long-term care insurance premiums limit changes every year, and it is advisable to consult with your tax accountant.

3. IRS SEC. 195 STARTUP COSTS

Section 195 defines startup costs as “costs incurred to investigate the potential of creating or acquiring an active business and to create an active business.” To deduct startup costs, the costs must be:

• incurred by an existing active business and must be incurred before the active business begins (Sec. 195(c)(1)).
• the costs must qualify as deductible ordinary and necessary business expenses.

If the startup costs meet the above two requirements, you can deduct up to $5,000 startup and organizational expenses incurred prior to the start of your business operation. The remainder of the startup costs is amortized over a period of 180 months.

There is a limitation of how much you can deduct if the startup costs exceed $50,000. Make sure to speak with a tax accountant. Also, you might want to begin operation of your business before the start costs exceed $5,000. That way, you can take a deduction of the startup costs during the first year of operation as ordinary and necessary business expenses instead of amortizing the costs over 180 months.

Examples of the startup costs include consulting fees, market research and travel expenses related to your business, payments to employees before your business opens, advertising, legal fees, state filing fees and accountant fees, all incurred prior to the start of active conduct of your business.

Interest, taxes and research and experimentation, and the cost of acquiring another business are not included in the startup costs. Acquisition costs of another active business must be capitalized. IRS Code Section 263(a).

4. Home Office Deduction

IRS allow self-employed taxpayers to take a home office deduction if the taxpayer uses part of his or her home exclusively and regularly for conducting business. You can deduct a percentage of your mortgage interest, insurance, utilities, repairs, and depreciation for the part of your home that is used exclusively and regularly for conducting business. The home office deduction calculation is complex, and you might want to consult with a tax accountant to ensure your deduction is done properly.
The deduction is allowed regardless of whether you rent or own your home if you can demonstrate that you use part of your home exclusively and regularly for conducting business.

5. Advertising and Promotional Costs

Advertising and promotional costs are expenses you incur as part of doing business. Therefore, these costs are deductible to arrive at your business taxable income. You can deduct the costs that you incur to advertise your products or services through Facebook ads, Google ads, a website, a billboard, a TV commercial, online marketing or solicitation mail.

Promotional costs are the costs your business incurs to make its products and services known to consumers, to manage its brand image or to provide information about its products and services. These include, for example, product giveaways, printing business cards, making a donation with a purpose of public recognition, or sponsoring a charitable event where the business intent is to reach more customers etc.

Remember that both advertising and promotional expenses must meet the IRS deductibility guideline, which states that the costs must be ordinary and necessary business expenses. If you have doubt, speak with a professional tax accountant.

Spending more on advertising and promotion can also help your business increase sales, and therefore increase revenue. Effective planning the advertising and promotional costs and subsequently on how to use the increased revenue can help your business pay less taxes. For more tax planning advice, speak with a tax professional or tax accountant.

6. Internet and Phone Bills

As a self-employed business owner, you can deduct the expenses for your phone, fax and internet that you incur for your business. If you use your phone and internet for both business and personal, apportion the expenses between business and personal. But remember you can only deduct the expenses that relate to your business.

Also, you may get a second phone number exclusively for business use or ask your phone carrier to itemize your phone bill. Having an itemized bill allows you to properly account for the business and personal use and to have supporting documents to prove the deduction to the IRS.

If you purchase a new phone or an internet cable to use for your business, you have a choice to either deduct the expenses as a cost in the tax year or to depreciate it over certain periods. Consult a tax accountant to see which option best suits your business.

Remember, all expenses must meet the IRS guideline of ordinary and necessary business expenses. If in doubt, seek assistance from a tax professional.

7. Business Insurance

You may deduct insurance premiums you pay in connection with your trade or business. For example, you can deduct premiums that you pay for general liability insurance, casualty insurance and property insurance for your business. If you use your home to conduct trade or business, you may deduct a portion of the property insurance that relates to your home office. See IRS Publication 533 for a whole list of deductible business insurance.

8. Business Travel Expenses

For a business travel expense to qualify as a tax deduction, it must meet the IRS guidelines which state the travel expenses must be ordinary and necessary expenses that you incur while traveling away from home for business, profession or job. The business-related duties must require you to be away from your tax home for longer than an ordinary day’s work, and you need to get sleep or rest in order to perform your duties.

In addition, the sole purpose for your travel must be to engage in business activity such as finding new customers, meeting with clients, or learning new skills that directly benefit your business. Going on a vacation and meeting a customer there does not count as a business purpose. You must be able to prove that the business trip was planned before you leave your tax home.

Business travel is an area that garners a lot of scrutiny from IRS, so proper keeping of records, business activities and receipts is very important.

Travel business expenses include the costs of transportation, lodging and meals you incur while away from your home for business. This may include, but is not limited to, the costs of:

1. Airfare, rental car, train fare, taxis, etc.
2. Shipping baggage, sample or display material
3. Meals and lodging
4. Dry cleaning and laundry
5. Personal and business calls
6. Tips for services related to business travel
7. Any other expenses that are necessary and ordinary and relate to your business trip

You can deduct 100 % of the travel expenses for business except for meals that is limited to 50%. If you are unsure, speak with a tax professional.

9. Vehicle Use

If you use your car for business, you can deduct the actual expenses or standard mileage costs that relate to your trade or business. Keep adequate records of the date, mileage and purpose for each trip. Do not claim personal mileage as business mileage.

The standard mileage rate is established annually by the IRS. For the tax year 2019, the rate is 58 cents per mile you drive your car for business use. You can either deduct the standard mileage costs or actual expenses but not both.

The standard mileage deduction is calculated by multiplying the total mileages driven for business purpose during the tax year by the standard mileage rate.

If you use your vehicle for business and personal, use the percentage of the mileage used for business to allocate the actual expenses. Actual expenses include, but are not limited to gas, oil changes, registration fees, repairs and car insurance. If your total cost is $6,000, and you use your vehicle 70% for business, your deduction is $4,200. (70% x $6,000).

10. Business Interest

Interest you pay on a business loan or on a business credit card is tax deductible. The credit card purchase must be made for business purpose. Interest paid on personal purchases is not deductible. If the loan proceeds were used for both business and personal purposes, you are required to allocate the interest expenses to both.

If you buy a capital property such as equipment, the interest you pay is not deductible. You need to add the interest paid to the basis of the property and take deductions over the estimated useful life of the asset as depreciation expense.

Interest assessed on income tax is not deductible. The penalties and fines you pay are also not deductible.
Interest deduction for businesses with annual gross receipts of $25 million or more is limited to 30% of the company’s EBITDA (earnings before interest, taxes, depreciation, and amortization). Small businesses with less than $25 million gross receipts can take the whole interest deduction. If unsure, consult a tax professional.

11. Qualified Business Income Deduction

Self-employed individuals may take a deduction of up to 20% of their qualified business income deduction, including income from their pass-through entity. Income from a C corporation does not qualify for this deduction. The 20 % deduction was added to the tax code to provide relief to small businesses that are not C corporations.

However, the deduction is subject to several limitations as discussed below:

Under section 199A, you can take a full deduction if your taxable income is below $315,000 if filing a joint return, or $157,500 if filing as single. The deduction is limited if your taxable income is above these thresholds.

The calculation for deduction is a rather complex. For each qualified trade or business, the deductible amount is the lesser of 20% of its qualified business income, or the greater of either 50% of its wages, or 25% of its wages plus 2.5% of its unadjusted basis immediately after the acquisition of all qualified property.
IRS Code Section 199A(d) defines qualified trade or business as any trade or business other than:

• a specified service trade or business. An example of specific service includes trades or businesses involving the performance of services in the fields of health, law, accounting, actuarial services, performing arts, consulting, athletics, financial services, brokerage services, or any other trade or business that relies on the reputation or skill of the staff.
• the trade or business of performing services as an employee

12. Rent

If you rent an office space or a property that you use for your trade or business, you can deduct the amount of the rent you pay. However, you cannot deduct rent for a property that you own, or which IRS deems unreasonable. Unreasonableness arises when you rent from a related party at rate higher than what is deemed to be market value of the property.
If you have a home office and meet the requirements for business use of your home, you can deduct part of the rent you pay on your home.

Disclaimer

This blog provides general information and is not intended for tax or legal advice. Discuss tax deductions matters with your professional tax advisor.