Are you a sole proprietor running your own small business? If so, you have to wear many hats, and one of the least enjoyable but most important ones is the tax accountant hat. It takes planning and superior recordkeeping to maximize your tax returns, but the time you put in up front will be worth it when you cash in on all of the self-employment deductions that apply to your enterprise.
The majority of your business-related self-employment deductions are going to be recorded on Schedule C or C-EZ, the IRS forms that you use to determine the profit and loss on your business (line 12 in your 1040 Form). Do not “double-report” these expenses and deductions by including them in your personal deductions in Schedule A.
Of the many deductions available to you, three of them offer greater savings because they are “above-the-line” – meaning that they are subtracted directly from your gross income on Form 1040, to determine your adjusted gross income (AGI).
- Retirement Plans – This is generally the most useful self-employment contribution that you can take. Establishing and contributing to a qualified retirement plan will significantly reduce your taxable income and provide a source of tax-deferred growth at the same time. Even though you are self-employed, you can still establish a 401(k) plan, SIMPLE IRA or a Simplified Employee Pension (SEP) plan for your own benefit.
- Self-Employment Tax – Since you are paying both the “employer” and “employee” component of your taxes, you are allowed to deduct 50% of the total self-employment tax that you pay.
- Health Insurance Premiums – As long as you are not eligible for coverage under your spouse’s health care plan, you can deduct your health insurance premiums and those of your spouse and dependents.
The deduction limit is determined by the difference between your net income/business earnings and your retirement plan and self-employment tax deductions. Should the subtractions wipe out your ability to claim health insurance deductions above-the-line, you can switch them to personal itemized deductions in Schedule A instead – just remember that you cannot claim them in both places.
Do not forget that under the Affordable Care Act you are subject to penalties if you fail to provide yourself with health insurance – assuming Congress and/or the Supreme Court does not change the rules by the time you read this article.
Other self-employment deductions that can be reported on Schedule C include:
- Home Office Deduction – You can deduct the percentage of your home used exclusively and regularly for business purposes against expenses such as utilities, mortgage insurance, and property taxes, or you can take a simplified flat deduction of $5 per square foot of office area. Home office deductions can receive extra scrutiny; make sure that your office truly qualifies.
- Depreciation – Depreciation on capital items such as computers, office furniture, and other assets may be deducted if the items have a useful life beyond one year and are used to generate income. You have several choices of depreciation method under IRS rules.
- Mileage – Business-related travel costs can be deducted by compiling expenses like gas, maintenance and tolls, or by taking a standard deduction per mile (57.5 cents for tax year 2015).
- Office Supplies – Items used in your business that do not qualify as capital items may be deducted as business expenses. Make sure that you keep all your receipts to justify the expenses.
Check the current instructions for Schedule C to make sure you understand all the deductions that might be available to you, and make sure you keep the necessary records to prove your deductions are valid. If necessary, seek the advice of a CPA or another qualified tax professional to help you identify and claim all of the self-employment deductions to which you are entitled.
You can then fill out your taxes confidently and focus on wearing your more enjoyable hat – that of a satisfied business owner.