Recently, the number of people starting small businesses has increased. Running a new business requires a good deal of planning, and learning to utilize your resources effectively greatly impacts your probability of success. Uncle Sam provides entrepreneurs support by offering various federal income tax breaks for self-employed individuals. Knowing the following seven deductions can provide sizeable benefits for self-employed individuals.
1. Health Insurance
Years ago, self-employed individuals could not deduct the full amount of their health insurance premiums like corporate entities could, but the playing field has been leveled.
For 2021, you may write off all your health insurance premiums if the business generates ample profit. You claim this deduction “above the line” on your personal tax return, which reduces your adjusted gross income for other tax purposes. It applies to premiums for health, dental, and long-term care insurance incurred for yourself, your spouse, and dependents under age 27.
2. Retirement Plan Contributions
Not only can self-employed individuals accumulate retirement assets on a tax-deferred basis, but they can also write off current contributions within generous limits. As with health insurance premiums, retirement plan contributions made by self-employed individuals are deductible “above the line.”
Your retirement plan options range from easy-to-administer plans — such as Simplified Employee Pension (SEPs) or Savings Incentive Match Plans for Employees (SIMPLEs) — to more complicated solo 401(k) plans and Keogh plans specifically designed for self-employed individuals. Generally, the limits match those of comparable employer-sponsored plans.
3. Home Office Deductions
Currently, you cannot deduct home office expenses as a corporate employee, but self-employed individuals may qualify for a significant deduction. This represents a clear advantage for self-employed people.
To qualify, you must use the home regularly and exclusively as your principal place of a business or a place to meet or deal with clients, customers, or patients in the normal course of business. If you have no fixed place of business, you may qualify if you do administrative work at home.
The business-use percentage determines the deduction. For example, if you use 10% of your home’s square footage for business, you can deduct 10% of your indirect expenses — such as utilities, repairs, and insurance — plus 100% of your direct expenses, such as painting the office or installing window coverings. In addition, you can claim a generous depreciation allowance under IRS tables.
The tax law also allows a simplified method to determine the deduction. You can deduct $5 for each square foot of home office space, up to a maximum total of $1,500. Note, you may switch between the traditional and simplified methods from year to year.
4. Business Vehicles
Do you drive your personal vehicle for business purposes? Even though you may also use the same vehicle for personal driving, you can deduct vehicle costs attributable to business travel based on the percentage of business use.
For example, suppose you use your car 80% for business driving in 2021. That means you can deduct 80% of your vehicle costs — such as gas, repairs, and insurance — plus a generous depreciation allowance, subject to certain limits for “luxury cars.” If you buy the car in 2021, you may also qualify for a Section 179 deduction and 100% bonus depreciation.
Be aware that the IRS is a stickler for documentation. Briefly stated, you must keep a contemporaneous log listing every business trip and proof of your expenses. Alternatively, you can cut down the expense recordkeeping by using the standard mileage rate of 56 cents per business mile (plus business-related tolls and parking fees) in 2021.
5. Business Travel
As pandemic-related restrictions loosen, you may start taking long-distance trips for business reasons. Self-employed people can deduct travel expenses, including round-trip airfare, hotel costs, meals, and other incidentals (such as tips and cab fares).
The primary purpose of your trip must be business-related. So, you can spend a little time on personal pursuits while away, but you cannot deduct a disguised vacation. As with business vehicle expenses, the IRS imposes strict recordkeeping rules.
6. Business Meals
You can generally deduct the cost of your meals while traveling away from home on business. But recent legislative changes have affected deductions for meals.
Normally, deductions for business meals were limited to 50% of the cost. However, the Tax Cuts and Jobs Act, repealed the deduction for business entertainment expenses, including certain meals, beginning in 2018. The IRS subsequently established that 50% of the cost of qualified business meals incurred in connection with entertainment — such as food and beverages bought for a client at a sporting event — remains deductible if charged separately from the entertainment.
For 2021 and 2022 only, the Consolidated Appropriations Act increases the deduction for qualified business meals to 100%. This temporary change applies only to food and beverages provided by a restaurant.
7. Self-Employment Tax
A self-employed individual must pay self-employment tax, the equivalent of the federal payroll taxes for employees. As with employees, the IRS imposes the Social Security portion of self-employment tax on amounts up to an annual threshold ($142,800 for 2021).
But self-employed people must pay both the employer’s and employee’s share of federal payroll taxes. That means the 15.3% tax rate for self-employment tax is double the 7.65% rate for employees. But you can claim an “above the line” deduction for half of the self-employment tax on your personal return.
Next Steps
Tax-saving strategies require forethought. Contact a Hantzmon Wiebel team member to plan for the 2021 tax year.
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Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.
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