Tax Tips for the Self-Employed
The first year I included self-employment income on my tax return, the increase in the amount of tax I owed the government surprised me. I had grown accustomed to receiving a refund check every year, but not only did I owe money to the government, I owed more than I expected.
When you work for an employer, you pay half of the Social Security and Medicare taxes owed to the government while your company pays the other half. When you are a sole proprietor, you are both the employer and the employee. The full amount of Social Security and Medicare taxes, 15.3 percent of your income, will come out of your pocket as the self-employment tax.
While this sounds like a disadvantage, a law seemingly designed to discourage people from owning their own business, it is offset by a number of advantages. When you file your taxes as a self-employed individual, keep these in mind in order to reduce your tax bill.
You can reduce income by 7.65 percent before calculating the 15.3 percent you owe for self-employment tax. This calculation is built into Schedule SE, the self-employment tax form.
You can deduct half your self-employment tax from your income. Even if you do not itemize your deductions, you receive this benefit. Half of what you owe for self-employment tax is deducted from the taxable income you report on your 1040. This represents what would be the employer’s portion of your self-employment income.
Focus on your other deductions. A wide variety of deductions are available when you operate your own business. The deduction with the biggest potential for reducing your tax bill is the home office deduction. If part of your home, whether you own a house or rent, is used exclusively for your business, you can claim this deduction. For example, if you use one room out of the eight rooms of your home for business, you can deduct 12.5% of certain expenses. Or, if you use 500 square feet out of a total of 2,500 square feet, you can deduct 20% of those expenses.
The allowed expenses include your rent or mortgage interest, utilities, property taxes, and insurance. Form 8829 covers the home office deduction if you are completing your taxes by hand.
Most of your other expenses related to your business will be deductible, as well. Consider any expenses you’ve paid in these categories — this is where holding onto your receipts and keeping accurate records in Quicken will be helpful.
- Supplies. Any operating supplies you purchased to help you run your business can be deducted from your self-employment income. Some examples include: printer paper and ink; blank CD-ROMs, flash drives, and hard drives for storing your data; and shipping materials and stamps.
- Communication. If you use a land line or a cell phone for your business, your bills are deductible. If the internet connection is necessary for the operation, its cost can be included. I use Skype in order to record interviews which are then published online within my business, so this cost is deductible for me.
- Advertising. The expenses you pay in order to make the public aware of your business through advertising, marketing, and public relations can be deducted from your business income for the purposes of calculating your tax bill. If you paid a designer to develop a logo, these fees are deductible as well. Expenses related to networking, or meeting people in your line of work, apply to this category.
- Business travel. Airfare, hotel charges, and rental car expenses are deductible when they are legitimately connected to travel for business purposes. Other expenses incurred while traveling for business are deductible, including storage, dry cleaning, and meals. Although you won’t need to provide receipts to the IRS for any expenses under $75, make sure you keep complete records including the business purpose of your travel.
- Vehicle expenses. If you drive your car for your business, you can deduct the actual business-related expenses such as fuel or take a deduction based on a per-mile rate set by the IRS each year.
- Asset depreciation. Any business equipment purchases such as your computer and office furniture are included in this category. For example, if you are a photographer your cameras and lenses are subject to a deduction for depreciation.
These are not the only deductions available to the self-employed. Using tax preparation software like TurboTax with thorough questionaires will ensure you will not miss any available deductions.