Self-employed? Don't forget to claim these tax deductions
Being self-employed can be enormously rewarding, offering professional independence, a pleasing absence of bosses and the thrill of building something on your own. The down side? Taxes, for one.
The total tax on your last dollar of income as a sole proprietor can be over 50 percent. That's because the top marginal federal tax rate is 35 percent and the Self-Employment (SE) tax rate is 15.3 percent on every dollar of net profit earned up to $128,400 in 2018. On top of that you may have to add state and local income tax. For example, income taxes for New York City residents can be 10.5 percent, or more.
The good news is that when you're self-employed, you can claim many deductions that aren't available to those who earn income only from wages. Here are several deductions that will directly reduce your net income from self-employment and lower your federal tax and your SE tax liability.
Retirement plan contributions
Among the biggest deductions the self-employed can claim are the contributions they make to their retirement plan. This deduction can be claimed as an adjustment to income on line 28 of Schedule 1, which then reduces your total income on the new form 1040.
My favorite type of retirement plan is the Self-Employed 401(k) profit-sharing plan, which allows the self-employed to make contributions both as an employer and as an employee. This type of plan, which is easily set up at any major brokerage firm, lets you make an additional contribution that's a percentage of net profit (this is the employer's profit-sharing component of the contribution) and a fixed-dollar amount up to the 401(k) contribution limits (which is $18,500, and $24,500 for anyone over age 50 in 2018). The maximum pretax contribution is $61,000.
To be allowed to make a deductible contribution for your 2018 tax return, you must establish the SE 401(k) account before year-end. But if you don't, you can still open and fund a SEP IRA or a traditional IRA any time prior to your tax filing deadline, plus applicable extensions. You can make a deductible SEP IRA deduction of up to 25 percent of net profit from self-employment, up to a maximum contribution of $55,000 in 2018.
The down side of a SEP IRA is that it can be expensive if you have employees. As the employer, you must open a SEP IRA and contribute a uniform percentage of pay to a SEP IRA for each employee.
Business equipment
Another big tax break for the self-employed was expanded under the new tax law. Self-employed business owners can deduct the full purchase cost of qualifying equipment bought or financed after 2017. The limit in 2018 was increased from $500,000 to $1 million. This deduction applies to machinery and equipment used in the trade or business, including computer equipment, office furniture, tools and even vehicles used for business (some restrictions apply, like the $25,000 limit for sport utility vehicles). This also applies to improvements made to nonresidential real property such as roofs, heating, ventilation and air conditioning, fire protection, and alarm and security systems.
Business use of your home
If you've used part of your home for business, this is a great place to look for deductions. Using Form 8829, you can either tally up your actual business expenses in using your home, or you can use the Simplified Option for Home Office Deduction. The simplified option allows anyone who meets the criteria to claim a deduction of $5 per square foot, on a maximum of 300 square feet, for a total deduction of up to $1,500.
In addition to being much easier to calculate, the simplified method also allows you to claim the full amount of home-related deductions (for taxes and mortgage interest) on Schedule A, and when the home is later sold, there's no recapture of depreciation for the years you used this option. Claim the expense for business use of your home on Line 30 of the Schedule C, Profit of Loss from Business.
Business use of your auto
If you drive your vehicle for business purposes and you keep a record of the mileage and the purpose of each trip, those miles are eligible for this deduction. For your 2018 tax return, you can claim it using the standard mileage rate of 54.5 cents per mile. Claim the deduction for car and trust expenses on Line 9 of Schedule C.
Legal and professional services
The cost for services you've paid to other professionals, such as attorneys, inspectors, bookkeepers, etc. is another deduction for the self-employed. Even part of the cost for tax preparation (attributed to your self-employment activity) can be included on Line 17 of Schedule C. This is especially valuable because the new tax rules disallowed the deduction for tax-prep fees as a miscellaneous itemized deduction, but the portion of your fee attributed to your self-employment tax forms remains deductible.
Rent or lease
If you rent or lease space you use in connection with your business, make sure to claim this as a deduction on Line 20 of the Schedule C. If you pay utilities separately, don't forget to include those on line 25.
Other expenses
Additional items the self-employed may be entitled to claim as deductions include:
- Half of the SE tax you pay
- Health insurance premiums you pay for yourself and dependents
- Advertising
- Cost of inventory
- Travel
- Costs of entertaining clients (limited to 50 percent of costs)
- Office supplies and related expenses
- Office equipment and furniture
- Commissions and fees paid
- Interest on loans used for business
- Taxes, fees and licenses
If you don't see a line specifically labeled on Schedule C for some of your business expenses, don't worry. List all other business-related costs, such as computer services, subscriptions, etc. on Part V, Other Expenses on the Schedule C, and the total of these other expenses are included on Line 27a.
