Seven Overlooked Tax Breaks for the Self-Employed
Managing tax obligations for small businesses or self-employed individuals can be challenging. Keeping your core business operating is hard enough, but when you add on the extra tasks of book-keeping and tax preparation it can be overwhelming for many people.
Here are seven overlooked tax breaks available to the self-employed that might offset your burden. Some of these deductions may only save a slight sum but others will yield substantial savings. When combined, they can provide a significant benefit.
2. Medical Expenses
Medical expenses are deductible, however, relatively few taxpayers will take this deduction. First, you must itemize to get this tax break (most taxpayers don’t). Second, you get a deduction only to the extent that your expenses exceed 7.5% of your adjusted gross income.
But there’s a big exception for the self-employed. You can deduct what you pay for medical insurance for yourself and your family, whether or not you itemize and without regard to the 7.5% threshold. You don’t qualify, though, if you’re eligible for employer-sponsored health insurance through your job (if you have one in addition to your business) or your spouse’s job.
Plus, if you continue to run your businesses after qualifying for Medicare you are eligible for are the premiums paid for Medicare as well as the cost of supplemental Medicare policies.
3. COVID-Related Sick & Family Leave Credits
Self-employed people don’t always get the same tax breaks other businesses are entitled to claim. But that’s not the case with the Covid-related sick and family leave tax credits enacted to help businesses struggling during the pandemic. For the 2021 tax year, you can claim sick and family leave credits similar to credits allowed for other businesses if you were unable to perform services as a self-employed person due to certain COVID-19 related circumstances during the first nine months of the year.
Generally, you may be entitled to a tax credit if you’re self-employed and were unable to work between January 1 and September 30, 2021, for one or more of the following reasons:
- You or someone you were caring for was subject to a federal, state, or local quarantine or isolation order related to COVID-19;
- You or someone you were caring for was advised by a health care provider to self-quarantine due to concerns related to COVID-19;
- You were experiencing symptoms of COVID-19 and seeking a medical diagnosis;
- You were exposed to COVID-19 or were waiting for the results of a test or diagnosis;
- You were getting a COVID-19 vaccination or taking someone else to get one;
- You or someone you were caring for was recovering from an injury, disability, illness, or condition related to the vaccination; or
- You provided certain coronavirus-related care to a son or daughter whose school or place of care was closed or whose childcare provider was unavailable for reasons related to COVID-19.
The credit amounts depend on various factors, such as the reason for missing work, when you missed work, and how long you were out. Use Form 7202 to calculate your credits.
4. Self-Employment Taxes
When you are self-employed, you are both an employer (of yourself) and an employee (of your business). As such, 50% of the Social Security and Medicare taxes you pay can be deducted on your personal IRS Form 1040 using Schedule SE.
Instead of having payroll taxes taken out of their paychecks like regular employees, you must pay a special 15.3% tax if you’re self-employed. The overall tax actually consists of two parts – a 12.4% Social Security tax and a 2.9% Medicare tax. The good news is that you get to write off half of the self-employment tax you pay. Plus, you don’t have to itemize to take advantage of this deduction.
5. Retirement Plans
Once you begin working for yourself, you are entitled to take advantage of tax-sheltered retirement plans. Unlike employees, whose options are pretty much limited to whatever their employer offers and an IRA, self-employed individuals can contribute pretax money to a simplified employee pension (SEP) or a solo 401(k), both of which have higher annual limits than regular individual retirement accounts. Additionally, you can still have an IRA.
You can also take advantage of a tax credit for contributions to your retirement plan if your income is under a specified ceiling. It’s called the Saver’s Credit, and it can trim up to $1,000 off your tax bill ($2,000 for married couples). The credit is worth 50%, 20%, or 10% of your contributions depending on your adjusted gross income. However, for the 2021 tax year, it’s completely phased out for single filers with an AGI of over $33,000 ($66,000 for joint filers).
6. Vehicle Costs: Business Use of a Vehicle
Self-employed people are entitled to the business auto expense deduction. Many people use their car part-time for work and part-time for personal use. The business percentage is a business expense and is, therefore, a legitimate deduction.
You can claim it by keeping a log of all miles driven as part of your business for the year, then multiplying that by the standard mileage rate of $0.575 per mile. You can also track actual expenses and hold onto receipts for everything from oil changes and maintenance to gas and depreciation, but your deduction will likely be bigger by using the standard mileage rate.
Another way to deduct vehicle expenses is to use the actual expense method. Here you add up all your car-related expenses for the year – gas, oil, tires, repairs, parking, tolls, insurance, registration, lease payments, depreciation, etc. – and multiply the total by the percentage of total miles driven for business reasons.
7. Home Office Deduction
The home office deduction is often overlooked or avoided because it’s complex and many people fear it can trigger an audit. In fact, only about 33% of all self-employed individuals claim it.
In reality, however, the IRS applies a simple two-part test. First, the dedicated space in your home must be used as your principal place of business, or it must have some other acceptable business purpose, and two, it must be used regularly and exclusively for the business.
The key to the home-office deduction is to use part of your home or apartment regularly and exclusively for your moneymaking endeavor. Pass that test and part of your utility bills and insurance costs can be deducted against your business income. You can also write off part of your rent or if you own your home, depreciation (a non-cash expense that can save you real money on your tax bill).
The IRS has come up with a simplified method allowing taxpayers to deduct $5 for every square foot that qualifies for the deduction. If you have a 300-square-foot home office (the maximum size allowed for this method), your deduction is $1,500. You get this tax-saver every year you have a qualifying home office.
When you’re on your own, it’s wise to take advantage of whatever assistance is available and this includes lowering your tax bill. Keeping good records and tracking expenses can make it easier come April. Self-employment can lead to more money, flexibility, control, or personal satisfaction, but once you learn what deductions you are legally entitled to you are well on your way to financial freedom.