Have you become self-employed and begun working from home? If so, you need to be aware of all your legal tax deductions so you can avoid overpaying your income taxes. Here’s how tax deductions work.
According to the Census Bureau, there are more than 27 million businesses in the United States that don’t have employees. The Census Bureau calls these businesses non-employers. Some are self-employed full time. Others work part-time as gig workers or running sideline businesses.
Self-employment can be financially and personally satisfying. But one big challenge is understanding self-employment taxes and deductions. Besides keeping track of your income and expenses, you also have to set aside money to pay your self-employment taxes, which are calculated based on your self-employment income. Here’s some information that will help you understand self-employment taxes and other tax deductions.
The self-employment tax is the Social Security and Medicare taxes you owe on your self-employed income. When you work for an employer, half of your combined Social Security and Medicare contributions (7.65%) are withheld from your paycheck. Your employer pays the other 7.65%.
When you’re self-employed and operating as a sole proprietor, you pay the entire amount yourself. You calculate the self-employment tax on your net earnings (income minus expenses) using IRS Schedule SE.
Tax deductions are a powerful tool for reducing your taxable income and, consequently, the amount of income tax you owe. For small business owners and self-employed individuals, understanding and utilizing tax deductions can significantly impact your financial health. By claiming eligible deductions, you can lower your taxable income, which may result in lower income tax payments or even a refund. This makes tax deductions a crucial aspect of tax planning for both businesses and individuals.
A tax deduction is an expense incurred for business purposes that can be subtracted from your taxable income. Essentially, it allows you to reduce the amount of your income that is subject to tax, thereby lowering your overall tax liability. Common business expenses that qualify as tax deductions include costs related to business equipment, supplies, travel, and more. By itemizing these deductions on your tax return, you can offset the costs of running your business and keep more of your hard-earned money.
Because you pay the full cost of Social Security and Medicare when you’re self-employed, the IRS gives you a break on your taxes. You can deduct half of your self-employment tax from your adjusted gross income. You calculate the deduction on Schedule SE and report it on Schedule 1 (Form 1040).
Schedule C is the tax form self-employed sole proprietors use to report income and expenses. To deduct your business expenses, you itemize deductions and list them on Schedule C. Then you deduct the total expenses from your business income to determine your net profit or loss. You transfer that profit or loss to Form 1040 to determine your personal taxable income.
The specific tax write-offs you can claim will depend on the nature of your business. But as a small business owner, you’ll likely want to claim all the deductions you’re entitled to. Some common deductible expenses are listed below. If you’re unsure about a deduction, seek help from a tax professional.
Here are some common tax deductions that might apply to your self employment income.
Do you run your business out of your house? If you do, and you’re operating as a sole proprietor, you may qualify for a home office deduction.
The simple way to calculate the amount of your home office deduction is to measure the area you use to do your work. Multiply the square footage of your workspace by $5 to determine your home office deduction. The most you can claim using this simplified method is $1,500 (300 square feet).
If you use a larger area for business or think you should get a larger home office deduction, you can use an alternate, more detailed method of calculating the amount. You can get those instructions by reading IRS publication 587. It has a more complicated list of terms and conditions, though. For example, homeowners might be able to include mortgage interest as part of their deductible expenses when calculating the home office deduction. Insurance premiums, utilities, and even depreciation could be included in these deductions, but the total amount you can deduct will be proportional to how much square footage your home office takes.
Note that the IRS stipulates your workspace needs to be used exclusively for your business to qualify for the home office deduction.
The Section 179 deduction allows businesses to treat the purchase of certain property as an expense instead of depreciating it. That means you can deduct the cost in one year instead of depreciating it over several years.
The Section 179 deduction is sometimes referred to as the expense deduction. You take it the year you put the property into use. Thus, if you bought a new business computer on December 31, 2023, but didn’t start using it until January 3, 2024, you would take the 179 deduction on your 2024 tax return.
To take advantage of the deduction, the property has to be used more than 50 percent for your business. You can expense up to $1,220,000 in equipment for tax year 2024. That goes up to $1,250,000 for the 2025 tax year.
There’s another limit to keep in mind, too. If you spend more than $3,050,000 in eligible equipment in a year, your expense deduction gets reduced dollar for dollar.
Your expense deduction can’t be more than your net income from the business. If it is, you may be able to carry the unused part forward as a deduction on your next year’s tax return.
Section 179 can also be used to expense business vehicles, but the amount that can be expensed is limited and the rules get more complicated. You should check with your accountant to determine the best way to treat business vehicles for tax purposes.
The qualified business income (QBI) deduction is one that lets eligible businesses deduct up to 20% of their qualified business income on their personal return. This deduction is reported on the personal tax return. Eligible businesses include most pass-through entities, such as sole proprietorships, partnerships, and S corporations.
The income that qualifies for the deduction is the net profit from operating the business inside the U.S. Interest, capital gains, dividends, and certain other types of income are not eligible for the deduction.
The deduction is only available to individuals with a total 2024 income (business income plus any other personal income) of no more than $191,950 for single taxpayers or $383,900 for couples filing jointly.
Not all businesses qualify. Among those that are excluded from taking the QBI are those in the fields of:
See the IRS.gov website for additional information.
Communications services and devices are an integral part of your business. Thus, your internet connection, cell phone, computer, tablet, landline phone, and other communications costs are all deductible expenses. The amount you can deduct for each communication expense depends on the percentage of time you use it for self-employment. For instance, if you use your home internet connection half of the time for business and half of the time for personal use, you can deduct half of the cost.
If you use your car or truck in business you can deduct the costs. The simple way to do that is to keep track of the mileage and take the mileage deduction, which is 67 cents per mile for 2024 and 70 cents per mile for 2025. Alternately, you can track all the expenses associated with the vehicle and deduct that amount. This is also called using the actual expense method, which can be beneficial if you have incurred significant expenses.
You may have to travel away from home to an out-of-state client, a trade show, or other business purpose. Such business travel is likely to be deductible as a self-employed expense. The expenses must be ordinary and necessary. You can’t deduct lavish or extravagant expenses.
Among the travel expenses you can deduct are hotel expenses and fares for air travel, busses, taxis, and rental cars while on your business trip. You can also deduct tolls, parking fees, and tips.
You can only deduct 50% of the cost of meals while traveling. As with all deductions, be sure you keep good records. Note the purpose of the travel, who you met with, and all your expenses so you can prove your deductions.
Depreciation and amortization are two important types of tax deductions that can help you manage the costs of business assets over time. Depreciation involves spreading the cost of a tangible business asset, like machinery or office furniture, over its useful life. This means you can deduct a portion of the asset’s cost each year, rather than all at once. Amortization, on the other hand, applies to intangible assets such as patents or copyrights. Similar to depreciation, amortization allows you to spread the cost of these intangible assets over their useful life.
Both methods help reduce your taxable income gradually, easing the financial burden of large purchases. If you’re interested in these deductions, it’s highly recommended to consult with a tax professional for assistance.
Educational products and courses that maintain or improve the skills you need in your business are tax deductible when you’re self-employed. For instance, if you took a course to learn how to build a website for your business or bought a book about marketing, it would be deductible. But you can’t deduct any education expenses that would train you for a new career.
If you work for yourself and have a net profit for the year, you may be able to deduct health insurance payments you make on behalf of yourself, your spouse, and children up to age 26. This deduction is not taken on Schedule C. It doesn’t reduce your business income for self-employment taxes. Instead, it’s an “adjustment to income” on Schedule 1 of Form 1040.
To qualify, neither you nor your spouse can be eligible for coverage through some other employer. Additionally, the amount you deduct can’t exceed the profit from your business. Thus, if it’s your first year in business and you didn’t make a profit, you wouldn’t be able to deduct any health insurance costs.
Every small business owner has certain products and services they need to run their business. The cost of those products and services is deductible. Depending on your business, these are some of the common deductions you may be able to take.
The items in this list are some of the more common expenses. You may have others. Keep good records (and receipts). As long as your expenses are ordinary and necessary for your line of business, they should be deductible.
Accurate record-keeping and documentation are essential when claiming tax deductions. To ensure you can substantiate your deductions, keep detailed records of all business expenses, including receipts, invoices, and bank statements. These records should be maintained for at least three years in case of an audit. When it comes time to file your tax return, you can claim your deductions by itemizing them on the appropriate tax forms. Using tax software or consulting with a tax professional can help you identify all eligible deductions and ensure you are maximizing your tax benefits.
While receipts are generally required to claim tax deductions, there are some exceptions. For example, you can claim mileage expenses for the business use of your car without keeping receipts (receipts aren’t issued by your car for mileage, after all). However, you must maintain accurate records of these expenses, including the date, time, and business purpose of each trip. The IRS allows you to use the standard mileage rate to calculate your mileage expenses, which can simplify the process. By keeping a detailed log of your mileage and other similar expenses, you can still claim these deductions even without physical receipts.
By understanding and properly claiming your tax deductions, you can significantly reduce your taxable income and lower your overall tax liability. This not only helps you save money but also allows you to reinvest more into your business, fostering growth and success.
Taxes can feel like an overwhelming prospect, but there are tools and strategies you can employ to help remove some of the guesswork. For starters, if you need more information about deductions in general, check out IRS publication 535 for more information. You can also consult with a tax professional to be sure you’re taking all the deductions you can. The deductions can help lower your net profit, and therefore lower your self-employment and income taxes.
ZenBusiness Money Pro can also help you approach tax season with the help you need to succeed. With a few simple clicks, you can track, categorize, and manage all your expenses and small business tax deductions.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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