You did it! You left your old job and started your own business! But it can be scary being your own boss and having your business’ success depend on your decisions. This can create a lot of stress and anxiety.
Now that you’re solely responsible for your business, you need to take advantage of any help that’s available to you. That includes financial assistance in the form of tax deductions and credits. Fortunately, there are a few of these available for self-employed people that can improve your business’s bottom line—and help ease your stress levels.
Although it may be difficult to determine which tax breaks you are eligible for, it is important to do so in order to maximize your tax return.
Auto Expenses
If you use your car for business or your business owns its own vehicle, you can deduct some of the costs of keeping it on the road. The rules of car expense deductions can be tricky but it is well worth your while to learn them.
The two methods of claiming expenses are:
- Actual expense method. You keep track of and deduct all of your actual business-related expenses and deduct an amount for depreciation each year.
- Standard mileage rate method. You deduct a certain amount (the standard mileage rate) for each mile driven, plus all business-related tolls and parking fees.
If you use a car for business activity, you can deduct expenses using either the standard mileage rate or the actual expense method. The standard mileage rate provides a deduction for a set amount per mile driven, while the actual expense method allows you to deduct the specific expenses incurred for the vehicle. You must use the standard mileage rate the first year you use a car for business, but you can switch to the actual expense method in a later year. You cannot, however, switch back to the standard mileage rate if you have used accelerated depreciation deductions, bonus depreciation, or a Section 179 deduction for the vehicle.
If you use your car for both business and pleasure, you can only deduct the business portion of the expenses on your taxes. This means that you need to keep track of how often you use the vehicle for business throughout the year, and add up the total at the end of the year. It’s not likely that the IRS will let you get away with claiming that 100% of your car’s use is for business if you only have one car. There are GPS-based apps that can help you track your driving, or you can use a paper logbook.
Social Security Taxes You Pay
If you are self-employed, you must pay 15.3% tax, which consists of a 12.4% Social Security tax and a 2.9% Medicare tax, instead of the payroll taxes that are taken out of regular employees’ paychecks. The good news is that you can write off half of the self-employment tax you pay. You don’t have to itemize to take advantage of this deduction; you can also claim the standard deduction.
The tax only applies to those who have earned more than $400 from self-employment. And for next year the maximum amount of self-employment income that is subject to the 12.4% Social Security tax is $147,000. Anything earned above that is not subject to the Social Security tax.
Expenses of Going Into Business
You may deduct $5,000 of the costs of getting your business started in the first year, and any remainder must be deducted in equal amounts over the next 15 years.
If you think your business will start making money right away, you might be able to get around this rule by not paying some bills until after you’ve started up, or by doing only a small amount of business to get started officially. But if your business, like many others, will have losses during the first few years, it might be better to take the deduction spread out over 5 years, so that you’ll have some profits to balance it out.
Health Insurance Premiums
You can only deduct medical expenses if you itemize, and most people don’t. Also, you can only deduct them if they exceed 7.5% of your adjusted gross income.
The self-employed can deduct what they pay for medical insurance for themselves and their family from their taxes, even if they don’t itemize their deductions, and regardless of the 7.5% threshold. However, they don’t qualify for this deduction if they’re eligible for employer-sponsored health insurance through their own job or their spouse’s job.
If you have a business and are eligible for Medicare, you can deduct the cost of your Medicare Part B and Part D premiums, as well as the cost of any supplemental Medicare policies or Medicare Advantage plans, without having to itemize your deductions.
Books and Legal and Professional Fees
Business books, including those that help you reduce or eliminate the need for legal and tax professionals, are fully deductible as a cost of doing business.
Fees can be deducted in the year they are incurred, but if they are for services that will be used in future years, they must be deducted over the life of the benefit.
Insurance
You can deduct the premiums you pay for any insurance you buy for your business as a business operating expense, including:
- medical insurance for your employees
- fire, theft, and flood insurance for business property
- credit insurance that covers losses from business debt
- liability insurance
- professional malpractice insurance—for example, medical or legal malpractice insurance
- workers’ compensation insurance that state law requires you to provide to your employees
- business interruption insurance
- life insurance covering a corporation’s officers and directors if you’re not a direct beneficiary under the policy, and
- unemployment insurance contributions (either as insurance costs or business taxes, depending on how they’re characterized by your state’s laws).
Deduction for Qualified Business Income
The new tax deduction is called the qualified business income deduction (a.k.a., the Section 199A deduction). It is available for owners of S corporations, partnerships, LLCs and other “pass-through entities” and self-employed people operating as sole proprietors. It is a tricky tax break with several special rules and restrictions, but the write-off is sizable if you can jump through all the hoops.
If you are self-employed, you may be able to deduct up to 20% of your qualified business income. This is income from your business that is included in your taxable income, minus certain capital gains and losses, dividends, interest income, wage income, and other items. However, this deduction is subject to limitations if your taxable income for 2022 is at least $340,100 for joint filers, or $170,050 for all other taxpayers. If you earn a high income from certain types of businesses, such as health, law, accounting, or performing arts, you may not be eligible for the deduction.
If you are self employed, it is worth looking into this complicated deduction.
Travel
If you travel for business, the cost of plane fare, operating your car, taxis, lodging, meals, shipping business materials, cleaning clothes, telephone calls, and tips can all be deducted.
Can you mix business with pleasure on your company’s dime? It’s okay, as long as business is the trip’s primary purpose. However, if you bring your family along, you can only deduct your own expenses.
Interest
If your business profit is more than $25 million, the interest expenses for credit used to finance business purchases is only deductible for 30%. Real property businesses with more than $25 million in gross receipts may elect out of the 30% limitation by agreeing to depreciate their real property over a somewhat longer period. Good records must be kept to demonstrate that the money was used for business purposes.
Equipment
Bonus depreciation is only available for new equipment, not used equipment. The Tax Cuts and Jobs Act (TCJA) changed how small businesses can deduct the cost of equipment. Most businesses can deduct 100% of the cost in a single year by using 100% bonus depreciation, expanded Section 179 expensing, and the $2,500 de minimis deduction. These deductions can be used for tangible personal property and computer software, but not real property. Real property must be depreciated over many years. Bonus depreciation is available only for new equipment, not used equipment.
For used or new personal business property placed in service from September 27, 2017 through December 31, 2022, 100% of the cost may be deducted in a single year through bonus depreciation. In later years, the first-year bonus depreciation deduction amount goes down, as follows:
- 80% for property placed in service during 2023
- 60% for property placed in service during 2024
- 40% for property placed in service during 2025
- 20% for property placed in service during 2026
- 0% for property placed in service 2027 or later.
The Section 179 deduction phases out on a dollar-for-dollar basis as the amount of equipment placed in service exceeds the investment amount threshold, which is $2,590,000 for 2022 ($2,930,000 for 2021). You can currently deduct up to an annual threshold amount of the cost of equipment and certain business assets you purchase and place in service that year and use over 50% of the time for your business under Section 179 of the Internal Revenue Code. The Section 179 annual limit is $1,080,000 for 2022. The Section 179 deduction phases out on a dollar-for-dollar basis as the amount of equipment placed in service exceeds the investment amount threshold, which is $2,590,000 for 2022.
If a business purchases more than $2.7 million in business property in a year, the amount they can deduct under Section 179 is reduced dollar for dollar by the amount their purchases exceed the limit.
If the cost of tangible personal property is $2,500 or less, the business may deduct it in a single year. An election must be filed with the tax return to use this deduction.
Advertising and Promotion
You can deduct the cost of advertising your business as a current expense. This includes websites, business cards, and Google Adwords. You can also deduct promotional costs that create goodwill for your business, as long as there is a clear connection between the promotion and your business. For example, if you name a team after your business, or list your business in a program, this shows evidence of the promotion effort.
Charitable Contributions
Essentially, if your business is a partnership, LLC, or S-Corp, you as the business owner can deduct charitable contributions made by the business on your individual tax return. If your business is a C-Corp, the business itself can deduct the charitable contributions.
If you have some old computers or office furniture that you no longer want or need, you can donate it to a school or nonprofit organization. Not only will the recipient organization be grateful, but you may also be able to get a tax deduction for the value of the donated items. However, if the equipment you’re donating has been fully depreciated (written off), you will not be able to claim a deduction.
Retirement Tax Shelters and Credits
Self-employed people have better options for tax-sheltered retirement plans than employees. They can contribute pretax money to a simplified employee pension (SEP) or a solo 401(k), which have higher annual limits than regular individual retirement accounts.
The Saver’s Credit is a tax credit you may be eligible for if you contribute to a retirement plan and your income is not too high. This credit can reduce your tax bill by up to $1,000 ($2,000 for married couples). The amount of the credit is based on your adjusted gross income, and can be worth 50%, 20%, or 10% of your contributions. The Saver’s Credit is gradually being phased out for single filers with an adjusted gross income over $34,000 ($68,000 for joint filers) and will not be available at all for the 2022 tax year.
Tax Planning
These are just a handful of the tax deductions available to business owners. Strongly recommend that you add a tax planner to your team, preferably one that has experience in working with businesses that are similar to yours. The tax laws are constantly changing, so make sure that you’re working with someone who is staying current.
Leave a Reply