There are a lot of benefits to being self-employed. Many would argue the ability to write off business expenses is one of those benefits. However, tax deductions can be a mixed bag. Incorrect deduction can draw the flaming eye of the IRS down on you. Even if you have nothing to hide, an IRS audit is a hugely inconvenient process that will require significant time and resources to resolve.
Self-Employment Tax Deduction
If you’re self-employed, you’re undoubtedly familiar with the dreaded self-employment tax. Employers generally pay half of a worker’s Social Security and Medicare, but self-employed workers are responsible for the whole amount (a combined 15.3 percent of your income).
Luckily, the IRS considers your “employer” portion a business cost if you’re self-employed, which means you can deduct half of your self-employment tax from your net income. This specifically applies to your income, not net earnings from self-employment.
Home Office Deduction
Although it may seem simple in theory, determining an appropriate home office deduction that won’t inflame the IRS is a delicate matter.
You essentially need to determine the cost of the physical workspace you use only for business and the cost of keeping it operational.
If, for example, your home office is 10 percent of your home’s square footage then you can technically also deduct the 10 percent of your home mortgage interest, utilities, home insurance, depreciation and even home repairs you performed during the year.
You can also deduct a percentage of your home phone or internet costs as long as you’re using them exclusively for business purposes for part of the time. The percentage matters – if you try to deduct 100 percent of your internet costs, you might run into problems.
Surprisingly, the IRS trusts taxpayers to be honest and often won’t press for proof until your deductions seem excessive. They generally determine what’s abnormal by comparing your deductions to similar businesses in your industry.
If the IRS suspects you’re deducting way more than you should for your home office, they’ll want you to provide evidence to justify your deduction. If you get audited for claiming all the above expenses as deductions, you’ll need to provide the records and math on how you came to those conclusions.
If you want to be on the safe side, H&H Accounting Services can help you determine an appropriate home office deduction for your self-employed business taxes.
Health Insurance Tax Deduction
As a self-employed worker you likely have to pay out of pocket for your own health insurance. Since you don’t have a group plan, your premiums might be higher (unless you’re eligible for your spouse’s insurance).
If you aren’t eligible for anyone else’s plan and you have to pay for your own private policy, you can deduct the entirety of your health insurance costs – including dental and some long-term care premiums. You may also be able to deduct your family’s premiums if they aren’t eligible for coverage through any other sources.
Meals, Travel and Vehicle Use Deductions
Like with home office deductions, these deductions are frequently responsible for getting self-employed people into trouble. These types of deductions are there to be used, but some self-employed filers either accidentally or intentionally abuse them, which may attract the attention of the IRS.
Meals are tax deductible business expenses when you’re traveling for business, entertaining a client or you’re attending an industry/business event or conference. Last year’s changes in the Consolidated Appropriations Act, 2021 provide the temporary ability to deduct the full cost of business meals instead of just half.
These deductions are not intended to be used for your own personal non-business meals, and deducted meals can’t be far more expensive than would be appropriate for the circumstance claimed. You do need to keep not only receipts but a record of the times and places where these meals are occurring.
You’re also now able to deduct food and beverage costs from a work event separately from the entertainment expenses – as long as they’re separated on receipts.
Travel expenses can be deducted for trips that require more than a workday, meaning the length of the trip necessitates a rest period and the associated costs (like getting a hotel room). You’ll need to be able to cite a specific business purpose for the trip (sales, training, etc.).
Receipts are vital if you want to claim travel expenses. You can potentially deduct the cost of transportation both to your destination and at your destination (taxis, rideshare) as well as meal and lodging expenses.
Many of the meal deduction rules apply to travel deductions. Particularly extravagant lodging or meals can cause issues. You also can’t deduct the cost of your family’s travel if you bring them with you – you can only deduct the business portion of your travel expenses.
Vehicle and mileage deductions also require milage and travel records. The 2021 standard mileage rate is 56 cents, a bit lower than the 2020 rate of 57.5 cents per mile. The calculation is generally business miles driven multiplied by the standard mileage rate. If you’re using your personal car or a leased car, the calculation is a bit more complicated.