As a self-employed person, you probably watched the development of the Tax Cuts and Jobs Act with some trepidation. The tax code is not often kind to the self-employed, nor are most of the changes to the code.
However, the new tax law retained most self-employment deductions and offers a few new forms of relief – even if you don't have billions of dollars parked offshore waiting to be repatriated. Consider these 15 tax deductions that can help you pump more of your proceeds into your business instead of the public coffers.
1. Self-Employment Tax Deduction – Unfortunately, in the eyes of the IRS, you are both an employer and an employee. Thus, you are responsible for both the employer and employee tax contributions to Medicare and Social Security. Fortunately, 50% of your employment tax payment (effectively your "employer" contribution) is tax deductible.
2. Qualified Business Income (QBI) Deduction – To level the playing field of corporate tax breaks, self-employed taxpayers now have a new deduction that assists small businesses with pass-through income (where individual tax rates apply). Sole proprietorships, partnerships, or S corporations may deduct up to 20% of QBI – although limitations can apply and some term definitions in the code are unclear.
3. Home Office Deduction – You can still deduct a home office as long as it is your principal place of business, used on a regular basis, and used for nothing other than business. IRS Publication 587, "Business Use of Your Home" gives details on eligibility and how to calculate your deduction.
4. Retirement Plans – If you use a 401(k), a simplified employee pension (SEP), or some other suitable qualified retirement plan, you can deduct your contributions to that plan. Not only will you score valuable tax deductions, you will also save responsibly for retirement by growing a tax-deferred nest egg. The IRS provides details on calculating contributions and deductions based on your choice of plan.
5. Office Supplies – As long as office supplies (non-capital expenses) are purchased and used only for your business, they may be considered as standard business expenses and deducted.
6. Depreciation – Capital expenses (that have a lifespan greater than one year) may also be deducted through depreciation if they are used to generate income for your business. Depreciation may apply to equipment used for both home and business. For details, see IRS Publication 946, "How to Depreciate Property".
The new tax law raised the depreciation limit to $1 million and the depreciation rate from 50% to 100% on certain qualified property bought and placed into service after September 27, 2017. See Publication 946 for more.
7. Educational Expenses – Do you attend seminars related to your business? Do you take continuing education classes or maintain subscriptions and dues in relevant professional societies? If these expenses relate to your profession, they may be deducted.
8. Health Insurance – Health insurance is frequently challenging for the self-employed. You may be able to reduce the burden by deducting premiums for you and your family if you meet the criteria outlined in IRS Publication 535, "Business Expenses."
Note: The new tax law eliminated the penalty for not having health insurance (aka the "Obamacare mandate") from 2019 onwards. Although there is no penalty going forward, we don't recommend forgoing healthcare insurance as a cost-savings exercise.
9. Communication Expenses – Expenses such as Internet and data services may be deducted in whatever proportion relates to your business. Basic local telephone services are not deductible for the first phone line in your home, even if you have a home office. Long-distance business calls on that line are deductible, as are the costs of a separate line used exclusively for business.
10. Other Travel Expenses – Some business travel expenses may be 100% deductible if they occur away from your tax home and are considered "ordinary and necessary". The new tax law has eliminated certain entertainment expenses, but the 50% deduction on food and beverage expenses still applies.
11. Promotional Expenses – Business-related advertising costs from full media promotions all the way down to simple business cards are deductible. Promotional gifts may be deductible as long as they are branded to your business.
12. Bank Fees – If you are careful to separate your business bank account from your personal accounts and maintain a clear line between transactions, you may be able to deduct some bank fees related to your business account.
13. Business-Related Interest Charges – Similarly to bank fees, interest on credit card balances and loans that are strictly related to your business may be deducted. Be sure to keep excellent and thorough records to prove the distinction. The new tax law creates limitations on interest deductions for larger businesses (gross receipts greater than $25 million), but, as a small business, your interest deductions should be unaffected.
14. Mileage – Do you use your car for business purposes? You can either take a standard mileage deduction (58 cents per business-related mile for tax year 2019 and 57.5 cents per mile for 2020) or take a deduction based on actual costs such as fuel, maintenance, licensing, and depreciation. Some public transportation expenses may also be deducted. Be sure to keep the personal and business-related mileage expenses separate, retain all necessary receipts, and keep good records as proof of business use. (See the pattern here?)
15. Contract Labor Costs – You may employ other independent contractors on a contract basis to provide services – for example, contracting with a web developer to create your website. Those expenses are generally deductible. You may also deduct the cost of tax preparation services used for the business-related part of your return.
Many ramifications of the Tax Cuts and Jobs Act have been in effect since tax year 2018. When setting up your tax plan and estimated payments, we suggest consulting with a qualified financial professional who is up to date on all of the law's implications. The goal of tax simplicity and postcard-sized tax returns is still far away for most of us – and, frankly, that day will probably never arrive for the self-employed.
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