Self-employment brings with it many benefits and drawbacks. When you work for yourself rather than for somebody else, you will inevitably have to take on many risks and respond to costs that would otherwise be handled by an employer. Not only are you the primary party responsible for creating sales/making money, but you also have to prove the value of your product or service to new and returning customers. In addition, you are responsible for paying the bills associated with operating a business: Internet and phone bills, employee payroll, and travel expenses – just to name a few.
Because you are financially responsible for operation costs, tax time can become a confusing and frustrating time. On the bright side, there are a lot of tax codes written specifically for the benefit of self-employed individuals. Because these tax codes help cover the costs associated with running your business, you should remember to claim those business tax deductions that you qualify for. Below are the most common tax benefits for the self-employed.
Self-employed individuals (and every worker who pays taxes) must pay taxes on Medicare and Social Security. For those who are self-employed, these taxes are nearly double that of other employees. However, the self-employment tax deduction allows you to deduct half of your Medicare and Social Security tax. The half that you are able to deduct is considered a business expense, since you would not normally pay the other half of the tax if you worked for somebody else.
Regardless of how you are employed, everybody must pay a tax on Medicare and Social Security. If you are employed by somebody else, you pay a set tax rate. If you are self-employed, you pay double that set tax rate, but you get to deduct half of that tax rate. For people employed elsewhere, your employer pays the other half of the tax rate that self-employed people pay.
A home office is most easily defined as a workspace (owned or rented) that an employee regularly uses explicitly for business. There are two options (and two separate forms) you can choose from when claiming the home office deduction. These two tax benefits for the self-employed include:
- Standard Deduction. This method helps you calculate the expenses of having a home office. It will require precise data to help you maximize how much return you can get. You will be required to determine exact measurements of your home office and gather total amounts you paid for costs associated with your home office.
- Simplified Deduction. If you don’t have precise data or the time to gather data, a simplified deduction is the easier method. The simplified deduction uses an IRS-determined rate to calculate the amount/square footage of your home office. The standard deduction is $1,500.
An often overlooked tax benefit for the self-employed involves your Internet, phone, and fax machine. Your communication devices, even if claimed on your home office deduction, can also be claimed elsewhere. Internet, phone, and fax expenses can be deducted if they directly relate to your business. For instance, your one phone’s monthly bill shouldn’t be deducted, since you use it for personal communications as well. However, if you have an Internet in an office which you rent out, you should claim the Internet costs since they directly relate to your business. If you have Internet at a home office that you also use for personal reasons, you would only deduct the percentage amount that you use the Internet for business (e.g. 50%).
There are several types of travel deductions that self-employees can deduct on returns. Travel tax benefits for the self-employed include:
- Meals (50% deductible)
- Transportation (100% deductible)
- Entertainment (50% deductible)
Your meals, transportation, and entertainment are considered travel deductibles if they are expenses directly related to business travel. You must have incurred costs stemming from meals, transportation, and/or entertainment during a business trip. A trip is considered business travel if you leave home in order to participate in business activity, such as:
- Meeting new clients
- Attending business conferences
- Finding new customers
- Looking for new facilities
Medical costs are considered a tax benefit for the self-employed if you do not have health insurance through a parent or spouse and you pay for your own insurance premiums. Health insurance premiums resulting from dental, medical, or long-term care insurance programs can thus be deducted on your tax return. If your spouse is covered under your health insurance plan, you can also deduct their premiums, as well as children or other dependents.
Note: Many of the tax benefits for the self-employed work on the honor system, so you should be extremely precise with your information. In the event of an audit, you are required to provide proof of every claim that you report to the IRS. To ensure that you are not found guilty of falsifying information, you should keep record of everything you claim. For the home office tax, this means you should safely store documents associated with mortgage interest, property interest, utilities (e.g. water, electricity), homeowners insurance, rental payments, maintenance fees/costs, office measurements, etc. For travel deductions, save all of your receipts from your trip. Finally, for medical deductions, work with your insurance company and doctor’s office to calculate every medical expense associated with your premium.