When it comes to self-employment, every penny counts – so you want to keep as much of your hard-earned money in your pocket. Whether you’re a consultant, small business owner, or freelancer, there are deductions you can make use of so you’re not leaving money on the table when it’s tax season.
Our guide to the differences between types of self-employment and the most common deductions you can use to boost your bottom line will put you on the path to success with the IRS.
Let’s get started.
What are tax deductions?
Every self-employed individual or small business dealing with business taxes in NYC has incomings and outgoings to provide a service. When the tax man comes knocking, tax deductions are a way to reduce your taxable income and lower your overall tax bill.
Tax deductions are claimed on your tax return and can be either above-the-line or itemized. Above-the-line deductions include IRA contributions or student loan repayments; itemized deductions are directly related to the cost of running a business, like home office equipment or car mileage.
Understanding the various tax deductions available to you can help you maximize your savings and keep more of your hard-earned money.
Sole Proprietorships Versus Independent Contractors
The tax implications for sole proprietors (such as a freelancer) as opposed to independent contractors (like IT consultants) are broadly similar, with some differences it’s well worth being aware of.
A sole proprietor is where the business isn’t separate from the person, and therefore no legal distinction. An independent contractor provides a service to other companies on a contractual basis.
The deductions both of these types of self-employed status can claim are broadly similar, though they may differ on technicalities. For example, sole proprietors can claim a home office deduction if they use a portion of their home exclusively for business purposes, while independent contractors may not be able to claim this deduction if they have a separate office space.
If you’re not sure which status applies to you or have a question about how to apply deductions according to your tax status, you can get in touch with Ahad&Co’s business tax accountant or personal tax accountant in NYC.
Common Deductions For Self-Employed Professionals
Now you’ve got the basics of tax deductions and which category you fall under down, here are some of the most frequently claimed tax deductions for self-employed individuals.
A major tax deduction for self-employed people is the cost of health insurance premiums for yourself and your family. This is a valuable tax benefit, as it helps to offset the cost of health insurance and reduce your taxable income.
To claim this deduction, you need to pay for health insurance yourself rather than any employer-sponsored plan, and the plan needs to be in your or your company’s name.
Home Office Deduction
With the rise of side hustles and hybrid working, many self-employed people use their home space for work. But did you know that you can claim home office expenses as a result?
There are two ways of working out the deduction – either by working out the square footage of the home office or the regular method, which involved itemizing each expense for the office. You can include a portion of rent, mortgage, insurance, utilities and internet bills depending on your circumstances.
One of the most useful deductions you can take advantage of is the self-employment tax deduction, which covers social security and Medicare. Currently, the self-employment tax rate in the US is 15.3%.
Usually, the contributions you make towards these would be matched by your employer, but with freelancing, you’ll need to pay more tax to match this level. As a result, the IRS allows self-employed individuals to deduct that equivalent amount.
If you use your car or another business vehicle, then you can claim back the running costs of the car on your tax return. Typical use cases are driving to job sites, meeting with clients and running business-related errands.
You can either deduct via mileage calculations or the actual expenses method. It’s vital to keep accurate records of business mileage and expenses for the vehicle, as the IRS may disallow the deduction if your records and receipts aren’t up to scratch.
Everyone should be adding regular contributions to their retirement accounts, and the IRS makes life easier for self-employed professionals by allowing deductions up to a certain limit.
Like the self-employment deduction, employees at a company would have an employer-funded retirement plan. For the self-employed, this is either a Simplified Employee Pension (SEP) or an Individual Retirement Account (IRA).
You can find more details from the IRS on pension contribution limits here. It is important to note that contributions to a traditional IRA may be tax-deductible, while contributions to a Roth IRA are not tax-deductible. If you’re feeling lost, please drop us a line to see how the best tax preparer in NYC can help.
Meals and Entertaining
Meeting with prospective clients or travelling for work where you need to cover meals mean you’ll incur expenses. Thankfully, these can be a tax-deductible perk as long as they can be proven to be related to business only.
Usually, the limit set by the IRS is up to 50% of the cost of the meal. For 2021 and 2022 only, this rises to 100% of the meal.
Only certain things fall under this category – for instance, groceries don’t count, whereas a meal at a restaurant does. Keep good records and receipts so you don’t lose out on claiming back.
Loan Interest and Bank Fees
If you have a separate business bank account, there may be monthly or annual fees associated with it. You can claim these fees back as a tax deduction.
Similarly, if you’ve taken out a loan to help your business, the interest payments on the loan can be a deduction. To claim a deduction for loan interest you must have a valid loan agreement in place, be obligated to pay the interest, and must have paid the interest.
Maximizing deductions is a key strategy for the self-employed to keep more money in the bank. By understanding the deductions available and keeping accurate records, you can always make sure you’re getting your dollar’s worth.
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