If you’re self-employed, you work hard to build your business and satisfy your clients, but your biggest client to make happy might just be the IRS. Here is what you should know about making sure that Uncle Sam is getting his fair share while at the same time ensuring you’re not paying out more than necessary. We provide comprehensive accounting and tax services in New England, contact us if you need help, we’d love to hear from you!
What is the Self-Employment Tax?
For purposes of our discussion, self-employment taxes are referencing taxpayers filing a Schedule C on their Form 1040. The self-employment tax represents the employer paid portion of Social Security and Medicare taxes. As an employee, you would pay one-half of the total taxes. This amounts to 6.2% on the first $118,000 in wages for 2016 and 1.45% in Medicare taxes regardless of the amount in wages that you earn. When you are self-employed, your total percentage paid is 15.3% as you are responsible for both the employer and employee portions. Fortunately, you are allowed to deduct one-half of the amount paid in self-employment taxes as a business owner. Self-employment taxes are paid on 92.35% of your net self-employment earnings.
Additional Medicare Tax
If you’ve done well this year, you may be required to pay an additional Medicare Tax of 0.9%. The tax is applied to taxpayers with combined wages and self-employment income that exceeds the following thresholds. Single $200,000 Married Filing Jointly $250,000 Married Filing Separately $125,000.
We hear all the time about the importance of saving for retirement. For self-employed individuals, the incentive to save can be great. You can substantially reduce your tax liability by contributing to one of the numerous retirement plans available to the self-employed.
SEP IRAs can be a substantial source for savings in addition to a tax benefit. For 2016, self-employed individuals can contribute up to $53,000, to a SEP IRA. Maximum contributions must be no greater than 25% of total compensation or $53,000, whichever is less. Contributions must be made by the extended due date for your tax return.
Self-employed individuals may contribute up t $12,500 ($15,500 for those over 50). The contribution is limited to total earnings from self-employment. SOLO 401(K) Solo 401(k) contributions have two parts: salary deferrals and profit sharing. Solo business owners may elect to defer up to $18,000 of their salary to a solo 401(k). An additional 20 – 25% of total compensation may be contributed via a profit sharing plan. Total contributions are a maximum of $53,000 ($59,000 for those over 50).
If you use a space in your home for business, you may qualify for the home office deduction. In order to qualify for this deduction, you must meet the following requirements. 1. It must be the principal place of business. 2. It must be used regularly and exclusively for business. If you meet these qualifications, you may use the actual method for determining your expenses, or you may use the simplified method. If you maintain good records and have tracked your receipts, the actual method of allocating home office expenses may be more beneficial. Under the simplified method, taxpayers are allowed a deduction of $5 per square foot over a maximum of 300 square feet of home office space.
If you incur expenses necessary to maintain or improve skills needed for your business, you may deduct these for tax purposes. These would include continuing education expenses necessary to maintain a professional license or classes you take to improve skills needed in your industry.
Access to the internet and telephone services are a crucial part of any business. The cost of these services specifically related to your business use are considered a tax write-off.
Professional Subscriptions and Periodicals
If you purchase specialty journals or publications related to your business niche, you may deduct the cost of these purchases on your return.
Health Insurance Premiums
If you pay for health insurance premiums out of pocket, you may be able to deduct these on your tax return. If you are married and filing a joint return, you are eligible only if you do not qualify for coverage under your spouse’s plan. The coverage extends to health, dental, and long-term insurance premiums paid. Payments may be made to cover you, your spouse, and any dependents under the age of 27.
If you borrow money for business purchases, any interest paid on these funds is deductible for tax purposes. This includes payments made by credit card, so long as the purchases were made for business.
Meals and Entertainment
50% of eligible meals and entertainment expenses incurred when traveling for business or entertaining may be deductible. The meals must be considered not to be lavish or extravagant for the circumstance. For these expenses, you will want to ensure the keep meticulous records should you draw the attention of the IRS.
If you drive for business purposes, then you’re in luck. The IRS allows taxpayers to deduct a standard mileage rate for business trips taken. If you keep accurate records of your expenses, you may choose to deduct the actual expenses associated with your vehicle. If you also drive the vehicle for personal purposes, you must allocate the total amount of expenses between personal and business. The standard mileage rate for 2016 is 54 cents per mile. If you need fleet vehicles, I was interviewed by the Washington Post to provide insights for a video they did for GM called, “How to Expand your Business Fleet” that educates business owners on how they can take advantage of tax deductions for new fleet vehicles in order to grow their business.
For travel expenses to qualify for a tax deduction, the trip must last longer than an ordinary business day and take the taxpayer away from their tax home. The purpose of the trip must be for business and can include appointments for meeting with prospects, clients, or acquiring and maintaining skills in your industry (e.g., conferences, seminars, etc.) Deductible travel expenses include the cost of transportation, hotel stays, and meals and entertainment.
Remember meals and entertainment expenses are subject to a 50% haircut. If you combine your business trip with a fun excursion not related to your business purpose, you may only allocate the portion of the trip related to the business at hand. Being self-employed has its challenges, but there are also many rewards to having your own business. Knowing what expenses can be deducted can ensure that you pay only your fair share in taxes.
Think You are Paying Too Much?
If you think you are paying too much in self-employment tax, then you really need to meet with a tax professional and make sure you are doing proactive tax planning. Being self-employed is great, but paying too much in taxes because you didn’t plan accordingly is not. One of my favorite quotes that relates to taxes is by Learned Hand, and he said “taxes are enforced extractions, not voluntary contributions.”
If you have any questions about tax deductions for the self-employed, or would like to learn more about our services, please feel free to contact us to schedule an appointment.