Tax Tips for Self-Employed
Updated to tax year 2024.
As an independent taxpayer, do envy your friends who are traditionally employed at tax time? It is true that having your own business, whether as a freelancer, independent contractor or other type of business owner, increases the amount of record-keeping required for tax purposes. And when you’re digging through all your self-employed income tax records and business receipts, it’s easy to wish for the days when you only had to enter taxable income from a W-2 form.
However, as a self-employed individual, you get some tax breaks that your employed friends don’t. You can deduct your business expenses, and these expenses can even reduce the amount of Social Security and Medicare taxes you pay as self-employment tax. Estimate your business income.
Unless you estimate your business income, tax planning is guesswork at best. You must know where you stand in terms of taxes before you can start planning your tax strategy. You don’t want, for example, to spend money in a year where you won’t be needing the deduction as much. If you anticipate being in a higher bracket of tax this year or the next, you will want to take the most deductions in the year that you are charged the highest rate. Estimating your business’s income can help you time your expenses to maximize your benefit. Time your business income.
Income is generally taxable when it is available to you. You can’t delay income by not cashing your checks, but you do have some control over the timing of when you bill customers and receive payment. Capital gains are another type of income that you can control. Time your business expenses. Time your business expenses.
There’s typically a surge in business equipment sales at the end of the year — and it’s not entirely because computers and printers are a popular holiday gift.
Business expenditures are counted as made in the year you purchase them, even if you use a credit card or other deferred payment plan and don’t pay for them until the following year. If you purchase a business asset by December 31, you can depreciate it almost immediately in your next tax return. You may be able to deduct the entire cost of an asset in a single year by taking a Section 179 deduction. You can’t deduct cost of goods until you sell them. Make the most of medical insurance deductions.
If you are ineligible for health insurance benefits through an employer, you can qualify to deduct health insurance premiums you bought for yourself, your spouse, and your dependents as an adjustment to income. This includes premiums paid for long-term health care insurance. It doesn’t matter if the policy is in your name or in the name of your business. Keep your business structure simple.
Unless you need to form a partnership or a corporation for business reasons, it may be best to stick with a sole proprietorship and report your business income and expenses on your personal income tax return using Schedule C. It’s the simplest way to file, and there’s nothing you have to disband if you move on to something else. If you are a sole owner looking for legal protection, you should always consult with your lawyer. They can determine if you need liability insurance or a single-member LLC. Automate your record-keeping.
Small business record-keeping doesn’t have to be hard these days. Shoeboxes and grocery bags full of crumpled up receipts are a thing of past. You can track everything using various personal finance software. These apps often sync easily with your bank account, making it easy to track all of your income and expenses in one place. It’s also less likely to make mistakes. Understand itemized deductions vs. business deductions.
By taking a business deduction instead of an itemized deduction, you reduce your adjusted gross income (AGI) and your self-employment tax. It’s better to deduct a business expense or part of an expense than itemize it, because you can save more money. You can deduct what you pay your children to work for your business if you are a parent. Kids pay less tax because they are in a lower tax bracket. In this case, you do not need to pay FICA tax or federal unemployment tax. You can deduct payments you make to your child, but only if the amount is reasonable and the child is actually working. You don’t have to worry about “kiddie taxes” either in this case, since earned income is not subject to them.
9. Take a deduction for your home office.
If your home office qualifies, you can deduct some of your non-deductible expenses such as rent, utilities, home insurance and mortgage payments. The IRS allows you to simplify the process by allowing you to take a simplified home office deduction. This allows you a flat rate for each square foot. This method allows you to take advantage of small business tax perks without the stress of lengthy calculations and record-keeping.
10. Avoid the IRS hobby-trap.
If your business is classified as a “hobby” by the IRS, you will have to report all income from your hobby. However, you will not be able deduct hobby expenses the same way you would for business expenses.
To avoid your business being classified as a “hobby”, it’s important to have made profits in three of the last five years. Even if this is not the case, you can still prove to IRS that you run a for-profit company if your business is conducted in a professional manner and you keep good records. Sure, you won’t be able to deduct your expenses, but hobby income is also not subject to self-employment tax, which otherwise would be 15.3% of your net income from the operation.
11. Turn charitable contributions into business expenses.
Under normal circumstances, you can’t deduct charitable contributions on your Schedule C. However, the donation can be considered a business expense if you give money to charities in exchange for something in return (like advertising for your business). This method gives you a larger tax benefit than an itemized charitable deduction. Keep detailed records of the benefits you received for your donation. Increase your self-employed retirement contributions.
As a self-employed small business owner, you have the option to fund your own retirement plan. You can contribute more to a retirement plan by opening a SEP IRA. Contributions to a typical IRA are limited. SEP IRAs are not limited by company size, and the contributions are tax-deferred. You won’t have to pay federal income taxes until you withdraw your money. In 2024, your contribution can be up to 25% of the total compensation you receive (which will increase to $70,000 in 2025) or $69,000. Track all business mileage.
Whether you take the standard mileage deduction or you keep track of actual expenses for gas, oil, etc., you must have good records to deduct vehicle expenses. Your records must include the mileage driven, business purpose and date. You should count all trips to the post office and to meet clients. To estimate your mileage deduction, try out our Mileage Reimbursement Calculator.
14. Check your liability for alternative minimum tax. You may want to do the opposite, if the alternative minimum taxes could cause you to lose certain self-employed deductions. It also calculates the tax liability without certain tax breaks such as deductions from state and local taxes, like real estate taxes, or certain business items. For more information on the tax breaks that would be affected by the alternative minimal tax, you can consult IRS Form 6251. AMT rates are either 26% or 28.5%. This is where tax preparation software like TaxAct(r) comes in handy. Once you input your information, we’ll crunch the numbers for you to ensure your taxes are calculated correctly. This is where tax preparation software like TaxAct(r) comes in handy — once you input your information, we’ll crunch the numbers for you to ensure your taxes are calculated correctly.
The bottom line
Handling taxes as a self-employed individual comes with its challenges, but it also offers unique opportunities to save. Planning ahead, staying organized and using the tips below will help you maximize your deductions and lower your taxable income. With the right tools and a proactive approach, you can make the most of the financial benefits that self-employment provides and approach tax time with confidence.
This article is for informational purposes only and not legal or financial advice.
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