Tips for Saving on Self-Employment or Small Business Taxes
- The tax deadline for 2020 has been extended to July 15th
- Contributions to tax-deferred retirement accounts, like a Traditional IRA or SEP IRA, can be deducted from your taxable income
- Self-employed workers may be able to deduct the employer’s half of payroll taxes
As we rapidly approach the new July 15th tax deadline for filing and payments, both small businesses and the self-employed that qualified for the extension will be putting the finishing touches on their tax returns.
For many, the extension was a small but needed reprieve during a difficult time. But as a general rule, being tax-savvy can be a big boon to overall profitability. This means taking advantage of all self-employment tax deductions available, in order to lower your tax bill.
Here are a few general things to keep in mind as you work on your taxes. (Note: For specific tax guidance, make sure to consult a CPA or tax professional.)
1. Contributing to a Tax-Deferred Retirement Account
Admittedly, so this one applies to everyone, not just the self-employed, but it’s so important. Not only is making a contribution to a qualified retirement account a way to lower your tax bill for the year, but you’re also taking an action that will benefit your finances over the long-term. Your Future Self will thank you!
If you run your own business, you may not have access to a company-sponsored plan, like a 401k. But that doesn’t make saving for your future any less important. Luckily, there are plenty of ways to do this on your own. If you are self-employed, you can consider setting up an IRA, SEP IRA, or Solo 401k. If you have a small business, a SIMPLE IRA or SEP IRA might be more appropriate.
Because of this year’s extenuating circumstances, contributions to some retirement accounts for the previous year (2019) can be made up until the July 15th deadline. A Traditional IRA, SEP IRA, and SIMPLE IRA all qualify for the extension and can be deducted from taxable income.
A Solo 401k requires contributions made by December 31st. And, a Roth IRA can be a great tool for saving for retirement, but contributions are not tax-deductible.
2. Deducting Part of Your Payroll Taxes
Being self-employed can be an amazing experience. Think about it, no bosses breathing down your neck, no long commutes sitting in a hot car, a flexible work schedule, and so on.
But as with anything, there’s always that other side of the coin, such as paying both the employer and employee sides of payroll taxes. Payroll taxes, which are sometimes referred to as “self-employment taxes,” include allocations to Social Security and Medicare. A traditional employer typically splits this bill.
According to Riley Adams, a CPA and founder of Young and the Invested, most self-employed people will pay both the 7.65% for the employee and the 7.65% that’s to be paid by the employer, for a grand total of 15.3% in payroll taxes. (And in actuality, this figure could be more, depending on your income.)
Luckily, it may be possible to deduct the employer’s portion from taxable income. Adams explains:
“In effect, you pay self-employment tax on 92.35% of your net business income, not gross income. This slight assistance can help offset some of the costs of running your business.”
3. Exploring a Home Office Deduction
“Any expense a self-employed person pays related to a home office used regularly and exclusively for their business, regardless of whether the space is rented or owned, can count as a tax write off,” says Adams. That said, this can be a somewhat tricky deduction, so proceed carefully.
Adams suggests drawing a diagram of your home office in reference to the overall size of your apartment or home. Then, take measurements. For example, if you believe that your home office is 300 square feet and your home is 3,200 square feet, then your office space makes up roughly 9% of your home.
Therefore, it may be possible to deduct 9% of the costs associated with maintaining the space, such as a mortgage or rent, utilities, homeowner’s insurance, home maintenance, property taxes, and so on.
Tip: There are two different methods for calculating a home office deduction; the standard method and the simplified method. You should check with a tax professional to see which is right for you.
4. Deducting Interest on a Business loan
Sometimes, borrowing money is the best—or only—way to expand a business. Though of course, this should be done judiciously. If you have procured funding from a small business loan that charges interest, you may be able to deduct that interest on your small business or self-employment tax form.
Similarly, you may be able to deduct interest paid on a credit card used to fund business operations.
Tip: The IRS assumes at least a market rate of interest on both loans made and collected by a business. With an interest rate that is zero or close to zero, the IRS may consider this a gift.
5. Deducting Health Insurance Premiums and HSA Contributions
Similar to a retirement contribution, a Health Savings Account (HSA) contribution is tax-deductible. In fact, HSAs are the only type of investment account that is “triple-tax-advantaged,” meaning that there are no income taxes due on contributions, no income taxes on withdrawals, and money grows tax-free.
Next, you’ll want to investigate whether you can deduct your self-employed health insurance premiums. According to Adams, your business must claim a profit in order to deduct health insurance premiums: “If your business claims a loss on your tax return, you are ineligible for this deduction.”
Additionally, you are not able to deduct premiums if you are covered by a workplace plan. (For example, if you only run your business as a side gig, and maintain traditional employment with health insurance.)
Of course, this is not an exhaustive list of ways to lower your small business and self-employment taxes. Further, we are not tax experts—thanks to Riley Adams, CPA and founder of Young and the Invested for his help, here. For a complete look at all of the possible small business and self-employed tax deductions, you may want to enlist the help of a tax professional or use one of the many tax preparation services.
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