Over the years legislators have written numerous lines into the tax code to soften the blow of the extra costs that self-employed taxpayers must shoulder as they do business. As of the end of 2022, the Tax Cuts and Jobs Act (TCJA), passed during the Trump administration, is the U. S. Congress’ most recent large tax legislation overhaul. It became effective with the 2018 tax year and made several changes to self-employed tax deductions. Many of them are temporary and set to expire in 2025, while others are permanent.
The law has affected small businesses in many ways, mainly via a qualified business income (QBI) deduction for pass-through businesses—those that pay taxes as individual taxpayer(s) rather than through a corporation. The deduction provides a great benefit for owners of sole proprietorships, partnerships, S corporations, and certain limited liability companies (LLCs), trusts, and estates. Eligible taxpayers can deduct up to 20% of their QBI. A pass-through’s QBI is the net amount of qualified items of income, gain, deduction, and loss from a qualified trade or business.
- The Tax Cuts and Jobs Act (TCJA), which went into effect in 2018, included several changes to tax deductions for the self-employed.
- If you’re self-employed, reviewing what you can deduct each year is important to make your business as profitable as possible.
- There are two ways of calculating a deduction for a home office and a vehicle used for business purposes. It pays to do calculations for both methods to see which is more financially beneficial.
- Meals with clients and business travel are deductible, but meals included with entertainment may not be.
- Premiums for insurance that you buy to protect your business and health insurance are legitimate deductions. And don’t forget startup, advertising, and retirement plan costs.
WATCH: 8 Tax Benefits For The Self-Employed
Eliminated or Changed Deductions
Some deductions that have been eliminated or changed post-TCJA include:
- Entertainment and fringe benefit deduction
- Employees’ parking, mass transit, or commuting expenses deduction
- Domestic production activities deduction
- Local lobbying expenses deduction
- State and local tax (SALT) deduction is now limited to $10,000 ($5,000 in the case of married filing separately)
- Deduction of settlement or legal fees in a sexual harassment case when the settlement is subject to a nondisclosure
Key provisions that are set to expire in 2025 include:
- QBI deduction
- SALT deduction cap
- Standard deduction will return to pre-TCJA levels
- Income tax rates will return to pre-TCJA levels
It is important to note that tax laws are constantly changing, and these provisions may be modified or extended at any point before 2025. Therefore, reviewing the most common self-employed taxes and deductions is necessary to keep you updated on any changes required to your quarterly estimated tax payments.
1. Self-Employment Tax Deduction
The self-employment tax refers to the Medicare and Social Security taxes that self-employed people must pay. This includes freelancers, independent contractors, and small-business owners. The self-employment tax rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare.
Employers and employees share the self-employment tax. Each pays 7.65%. People who are fully self-employed pay for both parts themselves. An additional 0.9% Medicare tax rate applies if income is above a certain threshold. The threshold figures as of 2023 are as follows:
- Married filing jointly – $250,000
- Married filing separately – $125,000
- Single – $200,000
- Head of household (with qualifying person) – $200,000
- Qualifying widow(er) with dependent child – $200,000
The income thresholds for additional Medicare tax apply to self-employment income and your combined wages, compensation, and self-employment income. So, if you have $100,000 in self-employment income and your spouse has $160,000 in employee wages, you’ll have to pay the additional Medicare tax of 0.9% on the $10,000 by which your joint income exceeds the $250,000 threshold.
Paying extra taxes to be your own boss is no fun. The good news is that the self-employment tax will cost you less than you think because you can deduct half of your self-employment tax from your net income when calculating your income tax. This is because the Internal Revenue Service (IRS) treats the employer portion of the self-employment tax as a business expense and allows you to deduct it accordingly.
Social Security and Medicare Taxes
It is important to note that the self-employment tax refers to Social Security and Medicare taxes, similar to Federal Insurance Contributions Act (FICA) tax paid by an employer. Therefore, when a taxpayer deducts one-half of the self-employment tax, it is only a deduction for calculating that taxpayer’s income tax. It does not reduce the net earnings from self-employment or reduce the self-employment tax itself.
Remember, you’re paying the first 7.65% whether you are self-employed or work for someone else. And when you work for someone else, you’re indirectly paying the employer portion because that’s money that your employer can’t afford to add to your salary.
Self-employed individuals determine their net income from self-employment and deductions based on their method of accounting. Most self-employed individuals use the cash method of accounting and will therefore include all income actually or constructively received during the period and all deductions paid during the period when determining their net income from self-employment.
2. Home Office Deduction
The home office deduction is one of the more complex deductions. In short, the cost of any workspace that you use regularly and exclusively for your business, whether you rent or own it, can be deducted as a home office expense.
You are basically on the honor system, but you should be prepared to defend your deduction in the event of an IRS audit. One way to do this is to prepare a diagram of your workspace with accurate measurements—if you are required to submit this information to substantiate your deduction—that uses the square footage of your workspace in its calculation.
In addition to the office space itself, the expenses you can deduct for your home office include the business percentage of deductible mortgage interest, home depreciation, utilities, homeowners insurance, and repairs you pay for during the year.
If your home office occupies 15% of your home, 15% of your annual electricity bill becomes tax deductible. However, some of these deductions, such as mortgage interest and home depreciation, apply only to those who own rather than rent their home office space.
How to Calculate the Home Office Deduction
You have two choices for calculating your home office deduction—the standard method or the simplified option—and you don’t have to use the same method every year. The standard method requires you to calculate your actual home office expenses and keep detailed records in the event of an audit.
The simplified option lets you multiply an IRS-determined rate by your home office square footage. To use the simplified option, your home office must not be larger than 300 square feet, and you cannot deduct depreciation or home-related itemized deductions.
If you’re pressed for time or can’t pull together good records of your deductible home office expenses, the simplified option is a clear choice. However, because the simplified option is calculated as $5 per square foot, with a maximum of 300 square feet, the most you’ll be able to deduct is $1,500.
If you want to maximize your home office deduction, you’ll want to calculate the deduction using both the regular and simplified methods to determine which will give you the greater benefit. If you choose the regular method, calculate the deduction using IRS Form 8829, Expenses for Business Use of Your Home.
3. Internet and Phone Bills Deduction
Regardless of whether you claim the home office deduction, you can deduct the business portion of your phone and internet expenses. The key is to deduct only the expenses directly related to your business. For example, you could deduct the internet-related costs of running a website for your business.
If you have just one phone line, you shouldn’t deduct your entire monthly bill, including personal and business use. According to the IRS, “You can’t deduct the cost of basic local telephone service (including any taxes) for the first telephone line you have in your home, even if you have an office in your home.” However, you can deduct 100% of the additional cost of long-distance business calls or the cost of a second phone line dedicated solely to your business.
4. Health Insurance Premiums Deduction
If you are self-employed, pay for your health insurance premiums, and are not eligible to participate in a plan through your spouse’s employer, you can deduct all your health, dental, and qualified long-term care (LTC) insurance premiums.
You can also deduct premiums you paid to provide coverage for your spouse, your dependents, and your children younger than 27 at year’s end, even if they aren’t dependents on your taxes. Calculate the deduction using the Self-Employed Health Insurance Deduction Worksheet in IRS Publication 535.
5. Meals Deduction
A meal is a tax-deductible business expense when you are traveling for business, at a business conference, or entertaining a client, although entertainment expenses per se are generally not tax deductible.
The meal cannot be extravagant under the circumstances; when traveling, you can either deduct 50% of the meal’s actual cost if you kept your receipts or 50% of the standard meal allowance if you kept records of the time, place, and business purpose of your travel but not your actual meal receipts. Unfortunately, this means that the desk lunch is not tax deductible.
The lunch that you eat alone at your desk is not tax deductible.
However, the deduction has been amended, according to the Consolidated Appropriations Act (CAA), 2021, H.R. 133: Division EE, Section 210: “Temporary allowance of a full deduction for business meals.” The bill temporarily allows a 100% business expense deduction for meals (rather than the usual 50%) as long as the expense is for food or beverages provided by a restaurant. This provision is effective for costs incurred after Dec. 31, 2020, and expires at the end of 2022.
The standard meal allowance is the federal meals and incidental expenses (M&IE) rate, updated every fiscal year, effective Oct. 1. The current rate and M&IE breakdown can be found on the U.S. General Services Administration (GSA) website. If the meals are not separately identified on the receipt, they cannot be deducted.
6. Travel Deduction
To qualify as a tax deduction, business travel must last longer than an ordinary workday, require sleep or rest, and take place away from the general area of your tax home (usually outside the city where your business is located). Further, to be considered a business trip, you should have a specific business purpose planned before you leave home, and you must engage in business activity—such as finding new customers, meeting with clients, or learning new skills directly related to your business—while you are on the road.
Handing out business cards during your friend’s bachelor party in Las Vegas does not make your trip tax deductible.
Keep complete and accurate records and receipts for your business travel expenses and activities, as this deduction often draws scrutiny from the IRS. Deductible travel expenses include the cost of transportation to and from your destination (such as plane fare), transportation at your destination (such as car rental, Uber fare, or subway tickets), lodging, and meals.
You can’t deduct lavish expenses, but you don’t have to choose the cheapest options available. However, remember that you, and not your fellow taxpayers, will still be paying the bulk of your business travel costs, so keeping them reasonable is in your interest. Your travel expenses for business are 100% deductible, including meals for 2022 (in 2023 revert to being limited to 50%.
7. Vehicle Use Deduction
When you use your car for business, your expenses for those drives are tax deductible. Make sure you keep detailed records of each trip’s date, mileage, and purpose, and don’t try to claim personal car trips as business car trips.
You can calculate your deduction using either the standard mileage rate determined annually by the IRS or your actual expenses. The standard mileage rates are $0.655 per mile in 2023, up from $0.625 in 2022. Using the standard mileage rate is easiest, because it requires minimal record-keeping and calculation. Just write down the business miles and the dates when you drive them. Then, multiply your total annual business miles by the standard mileage rate. This amount is your deductible expense.
To use the actual expense method, you must calculate the percentage of driving you did for business all year and the total cost of operating your car, including depreciation, gas, oil changes, registration fees, repairs, and car insurance. For example, if you spent $3,000 on car operating expenses and used your car for business 10% of the time, your deduction would be $300.
If you want to use the standard mileage rate on a car you own, you need to use that method in the first year when the vehicle is available for use in your business. Then, in later years, you can use either the standard mileage rate or actual expenses.
8. Interest Deduction
Interest on a business loan from a bank is a tax-deductible business expense. If a loan is used for both business and personal purposes, then the business portion of the loan’s interest expense is allocated based on the allocation of the loan’s proceeds.
You will need to track the disbursement of funds for various uses if the entire loan is not used for business-related activities. Credit card interest is not tax deductible when you incur the interest for personal purchases, but when the interest applies to business purchases, it is tax deductible.
That said, it’s always cheaper to spend only the money you already have and not incur any interest expenses. A tax deduction only gives you back some of your money, not all of it, so try to avoid borrowing money if possible.
9. Dues and Publications Deduction
The cost of specialized magazines, journals, and books directly related to your business is tax deductible as supplies and materials, as are dues or fees for certain professional membership organizations.
A daily newspaper, for example, would not be specific enough to be considered a business expense. On the other hand, a subscription to Nation’s Restaurant News would be tax deductible if you are a restaurant owner, and Nathan Myhrvold’s several-hundred-dollar Modernist Cuisine boxed set would be a legitimate book purchase for a self-employed, high-end personal chef.
As for membership dues or fees, you can’t deduct them for belonging to clubs “organized for business, pleasure, recreation, or any other social purpose.” Examples include “country clubs, golf and athletic clubs, hotel clubs, sporting clubs, airline clubs, and clubs operated to provide meals under circumstances generally considered to be conducive to business discussions." However, the IRS does make exceptions for groups that it considers do not exist for entertainment purposes. These are:
- Boards of trade
- Business leagues
- Chambers of commerce
- Civic or public service organizations
- Professional organizations such as bar associations and medical associations
- Real estate boards
- Trade associations
10. Education Deduction
Any education expenses you want to deduct must be related to maintaining or improving your skills for your existing business. The cost of classes to prepare for a new line of work isn’t deductible.
If you’re a real estate consultant, taking a course called “Real Estate Investment Analysis” to brush up on your skills would be tax deductible, but a class on teaching yoga would not.
11. Business Insurance Deduction
Do you pay premiums for insurance to protect your business, such as fire insurance, credit insurance, car insurance on a business vehicle, or business liability insurance? If so, you can deduct your premiums.
Some people don’t like paying insurance premiums because they perceive them to be a waste of money if they never have to file a claim. The business insurance tax deduction can help ease that dislike.
12. Rent Deduction
If you rent out an office space, you can deduct the amount that you pay for rent. You can also deduct amounts paid for any equipment that you rent. And if you have to pay a fee to cancel a business lease, that expense is also deductible.
However, you can’t deduct rent expenses on any property you own, even partially. Also, rent must be reasonable in amount. The need for a reasonableness test typically arises when you and the owner are related, but rent is considered valid if it is the same amount you would pay to a stranger.
13. Startup Costs Deduction
The IRS usually requires you to deduct major expenses over time, rather than all at once, as capital expenses. However, you can deduct up to $5,000 in business startup costs in the first year of active trade or business.
Tax-deductible startup costs include market research and travel-related expenses for starting your business, scoping out potential business locations, advertising, attorney fees, and accountant fees. The $5,000 deduction is reduced by the amount that your total startup cost exceeds $50,000. In addition, if you set up a corporation or LLC for your business, you can deduct up to $5,000 more in organizational costs, such as state filing fees and legal fees.
Professional fees to consultants, attorneys, accountants, and the like are also deductible at any time, even if they aren’t startup costs. Business expenses such as buying equipment or vehicles aren’t considered startup costs, but they can be depreciated or amortized as capital expenditures.
14. Advertising Deduction
Do you pay for Facebook or Google ads, billboards, TV commercials, or mail fliers? The costs that you incur to advertise your business are tax deductible.
You can even deduct the cost of an ad that encourages people to donate to charity while also putting the name of your business before the public in the hope of gaining customers. For example, a sign advertising “Holiday Toy Drive Sponsored by Robert’s Hot Dogs” would be tax deductible.
15. Retirement Plan Contributions Deduction
One deduction you can take going into business for yourself that is incredibly worthwhile is the deduction for self-employed retirement plan contributions. Contributions to simplified employee pension individual retirement accounts (SEP-IRAs), savings incentive match plan for employees (SIMPLE) IRAs, and solo 401(k)s reduce your tax bill now and help you rack up tax-deferred investment gains for later.
For the 2023 tax year, you could feasibly contribute as much as $22,500 ($20,500 in 2022) in deferred salary. If you’re 50 or older, you can make catch-up contributions of $7,500 ($6,500 in 2022) for a total of $30,000 ($27,000 in 2022). Additionally, you can contribute another 25% of your net self-employment earnings after deducting one-half of self-employment tax and contributions for yourself.
With a self-employed 401(k), the total maximum contributions cannot exceed $61,000 for 2022 and $66,000 for 2023, not counting catch-up contributions of $7,500 (up from $6,500 in 2022) for both employee and employer contribution categories. Contribution limits vary by plan type, and the IRS adjusts the maximums annually. Of course, you can’t contribute more than you earn, and this benefit will only help you if your business leaves you enough profits to take advantage of it.
16. Office Supplies Deduction
You can deduct the cost of business supplies and materials that have been “consumed and used during the tax year.” This includes such mundane concerns as copy paper, postage, paper clips, and pens. The IRS also allows books, professional instruments, and equipment, as long as they are used within the year. If the items’ use extends beyond a year, however, you generally must recover their costs through depreciation.
If you do keep certain supplies on hand on a regular basis from year to year, you may still deduct their cost if:
- You don’t keep a record of when they are used.
- You don’t take an inventory of the amount on hand at the beginning and end of the tax year.
- This method doesn’t distort your income.
I Rent My Home. Do I Qualify for the Home Office Expense Deduction?
Yes, you can qualify for the home office expense deduction if you meet all business use requirements. A renter can use the simplified or actual expense method based on the percentage of the home dedicated to business use.
Is a C Corporation Eligible for the Qualified Business Income (QBI) Deduction?
No. According to the IRS, “Income earned through a C corporation or by providing services as an employee is not eligible for the deduction.”
A C corporation files a Form 1120: U.S. Corporation Income Tax Return and is not eligible for the deduction.
You also cannot deduct any portion of wages paid to you by an employer and reported on a Form W-2: Wage and Tax Statement. Independent contractors and pass-through businesses are eligible for the deduction. They report their percentage of business income on a Schedule C: Profit or Loss from Business that accompanies Form 1040: U.S. Individual Tax Return.
Which Method Is Better for My Business Vehicle: Standard Mileage or Actual Expense?
It depends on the vehicle-related expenses that you have incurred during the year. For example, if you’ve spent significant money on maintenance (oil changes, brake pad replacements, new tires, etc.), car inspections, and registration, it may be more beneficial to use the actual expense method.
The Bottom Line
Most small business tax deductions are more complicated than this brief overview describes—it is the U.S. Tax Code, after all—but now you have a good introduction to the basics.
There are more deductions available than those listed here, but these are some of the biggest ones. Credit card processing fees, tax preparation fees, and repairs and maintenance for business property and equipment are also deductible. Other business expenses can be depreciated or amortized, meaning you can deduct a small amount of the cost each year over several years.
Remember, anytime you’re unsure whether a cost is a legitimate business expense, ask yourself, “Is this an ordinary and necessary expense in my line of work?” This is the same question the IRS will ask when examining your deductions if you are audited. If the answer is no, then don’t take the deduction. And if you’re unsure, seek professional help with your business tax return from a certified public accountant (CPA) or other credentialed tax preparer.