Self-employed? Here are 7 frequently overlooked ways to make the tax laws work for you
Have you launched a new business venture, recently become self-employed, or found yourself side-hustling up a storm? This tax season, make it your mission to get on top of your tax deductions and credits to relieve stress and boost your bank account.
We’ve covered tax deductions for your side hustle or new business entity before, so read that article first if you haven’t already. In this new blog post, we look at even more ways to take advantage of the available tax deductions for self-employed individuals. When it’s time to file your tax return, you’ll be grateful that you did.
For even more detailed information, download our free comprehensive guide to small business tax deductions, which is full of tips and strategies to help you understand the overall impact of business expenses on your tax return.
Here are 7 commonly overlooked ways to make the tax laws work for you:
1. Vehicle expenses
If you drive your own car for business, you can deduct the expenses associated with business travel. If you use your vehicle solely for business purposes, then you can deduct all of the operating costs; if you use your vehicle for both personal and business use, you will only be able to deduct the costs associated with business use, such as making deliveries, driving to a client’s location, buying business supplies, or any other work-related purposes.
There are two ways to calculate the vehicle expenses deduction:
- Standard mileage rate: The IRS provides a mileage rate that is updated annually. For the 2021 tax year, you can deduct 56¢ for every mile driven for business in 2021 (58.5¢ for 2022).
- Actual car expenses: Add up all your car-related expenses for the year (gas, insurance, oil, tires, repairs, parking, tolls, registration fees, lease payments, depreciation, etc.) and multiply by the percentage of miles driven for business purposes.
|Top tips: |
Keep detailed records of all costs associated with the business use of your vehicle Keep good records of the miles and dates you drive for work Consider using an app to help you keep a detailed log
2. Health insurance premiums
Although medical expenses are effectively deductible, not many taxpayers get to deduct them for the following reasons:
- You must itemize your deductions in order to deduct medical expenses must be itemized, and most taxpayers get a greater benefit from the standard deduction
- Deductions are only available to the extent that medical expenses exceed 7.5% of your adjusted gross income (AGI)
When you become self-employed, however, you can deduct health insurance premiums for yourself and your family. Note that this only applies if you are not eligible for any employer-sponsored health insurance through another job or your spouse’s job.
Another benefit is that if you continue to run your businesses after qualifying for Medicare, you can deduct the following health insurance premiums:
- Medicare Part B and Part D
- Supplemental Medicare (Medigap) policies
- Medicare Advantage plan
3. Special Social Security tax
In lieu of having payroll taxes taken out of your paychecks like a W2 employee, you need to pay a special 15.3% tax if you’re self-employed. This tax consists of two parts:
- 12.4% Social Security tax
- 2.9% Medicare tax
This tax is applicable to net earnings of $400 or more from self-employment during the year. For 2021, the maximum amount of self-employment income subject to the 12.4% Social Security tax is $142,800 ($147,000 for 2022).
The good news is that you can deduct half of your self-employment tax on your income taxes—without having to itemize to take advantage of this deduction.
4. Retirement tax credits and shelters
Once you become self-employed, the door opens wide to tax-sheltered retirement plans. W2 employees are generally limited to whatever their employer offers, with independent plans generally subject to lower contribution limits. When you work for yourself, you can choose from a number of options, such as contributing to a Simplified Employee Pension (SEP) IRA, traditional IRA, Roth IRA, or a solo 401(k).
Don’t be tempted to neglect your retirement planning in favor of growing your business. Contact us if you would like assistance ensuring you’re saving for your future in a tax-advantaged savings vehicle.
5. Covid-related sick credits and family leave credits
Generally speaking, the self-employed don’t always get the same tax breaks as other businesses. However, this is not the case when it comes to Covid-related sick and family leave tax credits.
If you found yourself unable to perform services as a self-employed person due to certain COVID-19 related scenarios during the first nine months of 2021, you might be eligible to claim the same sick and family leave credits enacted to help businesses struggling during the pandemic.
You may be entitled to a tax credit if you were unable to work in a self-employed capacity between January 1 and September 30, 2021 because you:
- Were subject to a federal, state, or local quarantine or isolation order related to COVID-19
- Were advised by a health care provider to self-quarantine due to concerns related to COVID-19
- Experienced symptoms of COVID-19 and had to seek a medical diagnosis
- Were caring for an individual subject to quarantine or self-quarantine
- Were exposed to COVID-19 or were waiting for results of a test or diagnosis
- Were getting a COVID-19 vaccination or taking someone else to get one
- Were recovering from an injury, disability, illness, or condition related to the vaccination
- Provided certain coronavirus-related care to a child 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 factors such as the reason for missing work, how long you missed work, when you missed work, etc. You can use Form 7202 to calculate your credits.
6. Qualified business income deduction
The qualified business income deduction (Section 199A deduction) is a relatively new tax deduction. It’s available for the following business legal structures: owners of S corporations, partnerships, LLCs, and other pass-through entities, along with self-employed individuals operating as sole proprietors.
The qualified business income deduction (QBI) has several special rules and restrictions, but it is well worth taking if you’re self-employed. We recommend consulting a qualified tax advisor to ensure you’re following the rules.
What is qualified business income, or QBI?
QBI is the net amount of business income, gain, deduction, and loss included in your taxable income (less certain dividends, capital gains and losses, interest income, wage income, and some other items).
Eligible self-employed individuals can generally deduct up to 20% of qualified business income (QBI) from their business. However, limitations apply if your 2021 taxable income is:
- $329,800 for joint filers ($340,100 in 2022)
- $164,925 for married taxpayers filing separate returns ($170,050 in 2022)
- $164,900 for single and head-of-household filers ($170,050 in 2022)
Another limitation phases out the deduction for high earners running certain types of businesses, such as accounting, actuarial science, athletics, consulting, health, law, performing arts, financial services, and more. See the full list on the IRS website.
When you buy new equipment for your business, you have two ways to declare the costs: depreciation (for assets) or expensing. The option you choose depends on the type and cost of the purchase. Depreciable assets are generally bigger-ticket items that cost more than $2,500 at the time of purchase and have a lifespan of over a year in service.
Below is some more information about the two options to help you decide which is best for your business:
Depreciate the cost
Depreciating the cost involves deducting the cost of the item over the number of years the IRS estimates to be the lifespan of the equipment. For example, a computer has a life of five years, which means you can write off the cost over five years according to depreciation formulas.
Also known as the Section 179 deduction, expensing the cost of an asset lets you deduct 100% of the qualifying cost in year one. In 2021, up to $1.05 million worth of equipment is eligible for expensing ($1.08 million for 2022).
Get your Small Business Tax Deductions Guide
We have put together a comprehensive guide of small business tax tips and strategies for tracking expenses, using detailed examples to help you take advantage of these tax savings.