by Jean Miller | Accounting News, News, Newsletter, Small Business, Tax, Tax Planning
Navigating the complex landscape of taxes as a self-employed professional can be overwhelming, but implementing effective tax strategies can help you shift from paying an excess of taxes to retaining more of your income. In this article, we’ll explore some key tax strategies that will help you keep more of your hard-earned money.
Choosing the Right Business Structure
Selecting the appropriate business structure is foundational to optimizing your tax situation. Sole proprietorship, partnership, limited liability company (LLC), S corporation, and C corporation each have distinct tax implications.
For many self-employed professionals, an LLC offers a balance of liability protection and tax flexibility. It combines a corporation’s limited liability aspects with a sole proprietorship’s simplicity, allowing for pass-through taxation while safeguarding personal assets.
On the other hand, an S-Corp can be advantageous for self-employed individuals aiming to minimize self-employment taxes. By structuring income into a reasonable salary and distributions, S-Corp owners can potentially save on taxes. Furthermore, the flexibility in offering fringe benefits, which can include health and life insurance, retirement plan contributions, and other perks makes an S-Corp structure a strategic choice for tax optimization and fostering business growth.
Itemized Deductions vs Standard Deductions
Understanding the differences between itemized deductions and standard deductions is crucial for self-employed professionals. While the standard deduction provides a fixed reduction in taxable income, itemized deductions can potentially yield greater tax savings if you have significant qualifying expenses. Common deductible items include business-related travel, home office expenses, and professional development costs. Carefully tracking and documenting these expenses can contribute to substantial savings during tax season.
Maximizing Retirement Accounts
Taking advantage of various retirement accounts can reduce taxable income and secure a financial future. Contributions to Individual Retirement Accounts (IRA) and Simplified Employee Pension (SEP) IRAs are tax-deductible, providing an immediate benefit. Solo 401(k) plans, designed for self-employed individuals, allow for higher contribution limits, enabling professionals to save more for retirement while minimizing their tax liability.
Understanding Constructive Receipt
The tax concept of constructive receipt states that income is taxable when it’s made available to you, even if you haven’t physically received it. Self-employed professionals can optimize tax planning by strategically timing invoices and income recognition. For instance, deferring income to a later tax year can help minimize current tax liability. Keep in mind that effectively leveraging this flexibility requires maintaining precise records and compliance with tax regulations.
Investing in Real Estate and Rentals
Incorporating real estate rental properties into an overall tax strategy offers diverse opportunities for tax benefits and savings. Property owners can capitalize on depreciation deductions, enabling them to deduct a portion of the property’s cost annually. This deduction can substantially lower taxable income, effectively reducing the overall tax liability.
Health Insurance Plans and Premiums
Health insurance premiums for self-employed professionals are generally deductible, reducing taxable income. Alternatively, S-Corp owners can generate significant tax savings by establishing a group health insurance plan, allowing the S-Corp to cover premiums through payroll. The utilization of Flexible Spending Accounts (FSAs) and Health Savings Accounts (HSAs) provides additional avenues for entrepreneurs to reduce taxable income, offering tax-free contributions, growth, and withdrawals for qualified medical expenses.
by Pete McAllister | Accounting News, News, Tax, Tax Planning, Uncategorized
There are some valuable tax deductions available for self-employed people. The key is knowing what they are and how they can help reduce your tax bill. Here are some key self-employment tax deductions to remember.
Home Office Deductions
This deduction allows you to deduct any portion of your home that is used specifically and regularly for work. There are two methods used for deducting home office expenses:
- Regular Method: To use this method, you will itemize the actual expenses incurred by completing form 8829. The list of deductible expenses includes furniture, appliances, utilities, insurance, maintenance, and repairs. If you plan to use this method, it’s important to keep accurate and detailed receipts.
- Simplified Method: To use this method, you will simply apply the standard deduction of $5 per square foot of home used for business, up to a maximum of 300 square feet. This is an easier way to account for home office expenses than the method above, but keep in mind that the 300 square-foot limit amounts to a maximum deduction of $1,500.
Vehicle Use for Business
You may be able to deduct the use of your vehicle on your tax return if you regularly use it as part of your business. There are two methods of calculating these expenses:
- Actual Expense Method: Employing this method authorizes you to deduct specific costs essential to operating your business vehicle, such as gas, oil changes, tires, registration fees, insurance, and depreciation. If you also use your business vehicle for personal use, you will need to calculate the portion of the operating costs that you generated due to business travel, and only that amount is deductible.
- Standard Mileage Rate: To use this approach, you will multiply the number of business miles driven by a flat per-mile rate. This rate can vary from year to year. For tax year 2021, it decreased from 57.5 cents to 56 cents per mile.
Health Insurance
If you are self-employed, you can deduct the cost of health care premiums for you and your family. This includes any children under 27 who are on your health plan, regardless of whether you claim them on your return. However, you won’t qualify for this deduction if you or your spouse are eligible for an employer-sponsored health plan.
Social Security Taxes
Employees who work for a company have payroll taxes deducted from their paychecks, and Social Security and Medicare are typically split equally between employee and employer (i.e., employee pays 7.65% and employer pays 7.65%). However, the self-employed pay the total 15.3% tax, which consists of a 12.4% Social Security tax and a 2.9% Medicare tax. The 15.3% tax is owed if your net earnings for the year are greater than $400. The good news for the self-employed is that they can write off half of the self-employment tax without the need to itemize. For tax year 2021, the maximum amount of self-employment income that’s subject to the 12.4% Social Security tax is $142,800. In 2022, it increases to $147,000.
Retirement Tax Shelters and Credits
If you are self-employed, you are eligible to contribute pretax money to a simplified employee pension (SEP) or a solo 401(k). This is in addition to an IRA account. Both SEPs and solo 401(k)s allow higher annual limits than regular individual retirement accounts.
Covid-Related Sick and Family Leave Credits
These tax credits are applicable for the first nine months of 2021. As a self-employed person, if you were unable to work (including telework or working remotely) due to certain COVID-19 related circumstances you are eligible to claim sick and family leave credits that are comparable to credits authorized for other businesses. These circumstances include personal sickness or quarantine, awaiting the results of a COVID test, and caring for a dependent who was sick or unable to attend school or daycare because of sickness, closure, or quarantine.
The credit amounts you are ultimately eligible for will depend on a few different factors, including the reason for missed work, timeframe of missed work, and duration of missed work. You will need to fill out the IRS’s Form 7202 to calculate your credits.
Deduction for Qualified Business Income
The qualified business income deduction (QBI) allows eligible self-employed and small-business owners (including sole proprietors) to deduct up to 20% of their qualified business income on their taxes.
In order to qualify, in general, total taxable income in 2021 must be under $164,900 for single filers and $329,800 for joint filers. These limits raise in 2022 to $170,050 for single filers and $340,100 for joint filers. If your taxable income is above these limits, complex IRS rules will verify whether your business income qualifies for a full or partial deduction.
Expensing
Expensing (also known as Section 179 deduction) lets you deduct the full purchase price of certain qualifying business assets in the year you bought them. The tax break applies to physical items—equipment (new and used), machinery, office furniture, off-the-shelf software, etc. Intangible assets such as patents and copyrights do not qualify, but improvements to business buildings as well as any installation of fire alarms and security systems do qualify for the tax break. You also cannot use this deduction for purchased land and real estate.
For tax year 2021, up to $1.05 million worth of equipment is acceptable for the immediate write-off of expenses, but this amount decreases if you put more than $2.62 million of new assets into service over the course of any single year. The equipment must have been purchased (or financed) and placed into service by December 31, 2021.
by Stephen Reed | Accounting News, News, Tax, Tax Planning, Tax Planning - Individual
Understanding self-employment taxes can be intimidating, but it’s important to educate yourself so you don’t miss out on deductions that can lower your tax bill. Below is a list of 15 self-employment tax deductions you may be eligible for as a freelancer or a self-employed individual.
1. Self-employment tax deduction
Self-employment tax is the portion of Medicare and Social Security taxes that self-employed individuals are required to pay, but you can claim 50% of this as an income tax deduction. For example, a $1,000 self-employment tax payment reduces taxable income by $500.
2. Qualified Business Income (QBI) Deduction
As of January 1, 2018, self-employed taxpayers can deduct generally 20% of their qualified business income from qualified partnerships, S corporations, and sole proprietorships.
3. Home Office Deduction
If your home office is your primary place of business – and used solely for your business – you are permitted to deduct it from your taxes. You can also deduct a percentage of household expenses such as electricity, gas, water, trash, cleaning services, and certain repairs to the home.
4. Retirement Plans
If you use a qualified retirement plan, such as a 401(k), an IRA, or a simplified employee pension (SEP), you are able to deduct your contributions to that plan.
5. Office Supplies
Provided they are used solely for your business, materials such as tools, basic office supplies, and machinery (including service expenses) may be deducted.
6. Depreciation
Capital expenses that experience the gradual loss of value (particularly business equipment or buildings) through increasing age, natural wear and tear, or deterioration may be deducted if they are used to generate income for your business.
7. Educational Expenses
Business-related educational expenses, such as continuing education classes, seminars and conferences, conventions and trade shows, and subscriptions and dues for industry organizations can all be deducted.
8. Health Insurance
If you are self-employed or own more than 2% of your S Corporation, you can deduct health insurance premiums for yourself and any dependents under the age of 27.
9. Advertising and Promotion
Any materials or services used to promote your business, such as business cards, web hosting, full media advertisements, etc. are deductible.
10. Internet Fees and Communication Expenses
Internet costs can be deducted, but only the percentage of time that it’s used for business purposes. Cell phone services also may be deducted in the proportion that it relates to business usage. To keep the personal vs. business line clear, it’s recommended to have separate computers and phones for business when possible.
11. Mileage
If you use your car for your business, you can take a standard mileage deduction, or take a deduction based on actual costs of fuel, maintenance, licensing, and depreciation. Some public transportation expenses are also deductible. Good record and receipt keeping as proof of business is key here.
12. Bank Fees and Interest Charges
As long as your business bank account is separate from your personal account, some bank fees connected to your business account may be deductible. Likewise, you can deduct interest on credit card balances and loans that are directly linked to your business.
13. Travel
Some business travel expenses can be deducted by 100% if they occur away from your home office and are considered necessary. Under the new Tax Cuts and Jobs Act, certain entertainment write-offs have been removed, but the 50% deduction on food and beverage expenses is still applicable.
14. Security System
If you work from a home office, you can deduct a percent of the expenses of a total home security system, and the purchase and installation of the system can be included when calculating depreciation.
15. Moving Expenses
If you move more than 50 miles from your location for business purposes, you are able to deduct most incurring expenses, such as transportation, packing, and utility connection fees.
