If you are self-employed and a parent, you qualify for a number of additional tax deductions and other benefits. Most of the benefits derive from deductions and tax credits on your income tax. Deductible expenses include health care, childcare, and education. As a parent, you may also qualify for special benefits. With this in mind, the following expenses could decrease your annual tax liability.
- Most childcare expenses can give you up to $3,000 in annual tax deductions per qualified child.
- Families can deduct most healthcare expenses over 7.5% of their adjusted gross income (AGI).
- Some deductions for education expenses can be filed retroactively for previous tax years, starting as far back as 2018.
- Self-employed parents can employ their children and pay them a small salary that is tax-free.
Tax Considerations for Self-Employed Parents
Child Tax Credit and Other Dependent Credit
With an estimated 16 million self-employed workers in the U.S., these deductions can impact millions of households. See which of them apply to you.
You can claim a child tax credit of $2,000 for each child under the age of 17 and $500 for children 17 and older or other dependents. In order to claim the full credit, your modified adjusted gross income (MAGI) must have been $200,000 or less if you file single or $400,000 if you are married filing jointly.
Note, for the 2021 tax year, the Child Tax Credit was raised to $3,000 for children ages six through 16 and $3,600 for children under six. The credit was paid in monthly advance payments starting in July 2021. This revised credit was not extended to 2022, thus, for 2022 thru 2025, the tax credit reverts back to 2020 level—$2,000 for children under 17 years old and only being partially refundable.
Paying a daycare center, babysitter, or even summer camp fees for a child can be a lot cheaper with tax benefits. A child which constitutes a qualified tax dependent who is 13 or younger, as well as a disabled dependent of any age, make parents eligible for a tax credit that can ease their federal income tax obligation.
- Up to 35% of qualifying child care expenses (capped at $3,000) for a single child.
- Up to $6,000 for multiple children or dependents.
This tax credit is intended for both employed and self-employed parents and guardians who earn income regularly. Individuals and couples who have been unemployed for a part of the year can also use it. To qualify, all the following conditions must be met:
- You must have earned income in the past tax year (both your spouse and you if you are filing together).
- You must be the child’s (or dependent’s) custodial parent or caretaker.
- You must either work and earn an income, or actively be looking for employment.
- Your child or dependent must be under age 13—unless they have a physical or mental disability that makes them unable to care for themselves.
- The provider(s) of childcare must not be your dependent or spouse, nor the child’s parent.
The IRS has a broad spectrum of expenses it considers childcare-related, which are not limited to daycare and babysitters. The full list of potentially eligible expenses includes the following:
- Babysitter or licensed childcare center
- Maid, housekeeper, or cook who cares for the child or dependent
- Summer camps, day camps, and even sports camps can qualify if they care for the child or dependent while the parents are working. Overnight camps are not included and do not qualify
- Before-school and after-school care for children under age 13
- Nurse, or other care providers for disabled children or dependent.
Since January 1, 2020, all qualified health expenses that exceed 7.5% of your AGI, including premiums, are tax-deductible. This applies to unreimbursed medical expenses and doesn’t cover cosmetic treatments.
Qualified health expenses that apply to children and their parents are as follows:
- Preventing, diagnosing, and treating mental or physical ailments
- Surgery and body modification strictly for health purposes (and not cosmetic)
- Transportation to a healthcare provider
- Health insurance premiums
- Prescribed medication
The IRS revised its previous decision and lowered the minimum AGI requirement for medical expense deductions from 10% to 7.5%.
Qualified self-employed individuals can write off 100% of their health insurance premiums. Taxpayers can apply this deduction on the first page of Form 1040—this is available to self-employed individuals regardless of whether they itemized or not.
Since education is not considered a necessary expense in most cases, there are fewer avenues to decrease your annual tax liability through your child’s school and college fees. However, there are still several cases that could apply.
College Tuition Fees and Expenses
This deduction was extended to the end of 2020. You could deduct expenses of up to $4,000 for 2020 and all years prior if your income was $65,000 or lower ($130,000 for married couples).
However, individuals with income between $65,001 and $80,000 ($130,001 and $160,000 for married couples) only qualified for a $2,000 deduction. If you didn’t claim the deduction for a prior year, you need to file an amended tax return with Form 1040X.
College Tax Credits
Taxpayers with a modified adjusted gross income (MAGI) of $90,000 or less (and married couples with a MAGI of $180,000 or less) are eligible for the American Opportunity tax credit. This credit can reduce your taxes by up to $2,500 per year for four years of college.
If this option isn’t available, you can try the Lifetime Learning Credit. It can lower your tax by 20% of the first $10,000 you spend on enrollment and tuition fees with a cap of $2,000.
For 2021, single taxpayers must have a MAGI of $69,000 or less to qualify ($138,000 for married couples). For 2022, the Lifetime Learning Credit is phased out for taxpayers with modified adjusted gross income in excess of $80,000 ($160,000 for joint returns).
Coverdell Education Savings Account (ESA)
You can invest $2,000 per child each year into a Coverdell ESA. These contributions are not deductible, but all distributions you make through this savings account are tax-free to the beneficiary—as long as they are used to pay the costs of lower, middle, or higher education.
The contributions can be made for children under 18. If your child does not go to college when the time comes, you can transfer the funds to another child or relative. High-income individuals and families are not eligible for an ESA.
Student Loan Interest Deduction
Interest on loans for college tuition or vocational school is also deductible. The deduction limit for qualified students is $2,500, but higher-income families are phased out. The tax deduction gets reduced and eventually phased out, depending on your income.
For 2022, individuals with an income of $70,000 or higher ($145,000 for married couples) will see a gradual reduction in the amount of interest that's deductible. You can't claim the deduction at all if your income is $85,000 or more ($175,000 for married couples filing a joint return).
Child Support for Self-Employed Parents
Income received from child support is not taxable according to the IRS. Child support payments are typically calculated based on the net income of the paying individual. If that individual is self-employed, a number of issues can arise.
This is due to the subjectivity found in calculating net income for the self-employed. Generally speaking, self-employed income is calculated by deducting expenses required to operate the business from the total income generated by the business. Under such a scenario, the self-employed parent could potentially deflate income by claiming unnecessary business expenses, thereby reducing a child support obligation.
Income used to calculate child support payments for self-employed parents varies widely by state. Certain courts do not permit the consideration of tax exemptions or expenses that would have been incurred irrespective of the business, such as utility bills.
Due to the inherent subjectivity and potential for manipulation in claiming net income, the self-employed parent could be required to legally prove their income. The means to achieve this would vary depending on the applicable jurisdiction but is likely to require financial records, tax documents, and even bank statements to justify income.
If the spouse of the self-employed parent suspects inaccurate income reporting, they may turn to a certified fraud examiner to uncover concealed assets or a forensic accountant to examine financial records for exclusions.
Hiring Your Child
Sole proprietors (or partners, if they're both the parent of that child) and self-employed individuals can hire their children if they are under 18 years of age. You can pay your child up to the standard deduction—$12,550 in 2021 and $12,950 for 2022—and they will not owe income tax or most employment taxes. You can even deduct this wage as a business expense.