Self-employment carries with it the burden of managing expenses independently. Unlike those who work with automatic paycheck adjustments, fine-tuning the numbers to fit your budget and to balance them with the cost of running your business is not an easy task. On top of which, expenses, being the most burdensome financial nuisance in running a business, minimizes your profitability. Additionally, mismanagement of these finances incurs unnecessary penalties when undervalued or misrepresented in your statements. Therefore, it is crucial for you to be knowledgeable about the deductions to take advantage of.
What Are Tax Deductions?
Tax deductions are expenses that reduce your taxable income and ultimately your tax bill. They are granted to those who incur necessary expenses to yield a profit. There isn’t a limit to the number of applicable deductions you can take. Deductions differ depending upon the nature of your business.
Self-employed contractors are compelled by the Internal Revenue Service (IRS) to report on Form 1099. It requires you to classify yourself according to the nature of your venture. In which case, you may qualify for distinct deductions and minimize your tax liability.
For sole proprietors, Schedule C of Form 1040 is required for claiming deductions. Filing it, allows the IRS to properly assess your deductible expenses covered in a taxable period.
If you incur below $5,000 of business expenses, the Schedule C-EZ form may be a better alternative. In using this form, you must utilize the cash method of accounting.
You must not operate on an inventory-basis in creating products. You also must have earned a significant amount of active profit for that period.
Moreover, your company must not have had any employees, depreciation of business assets entries, or home expenses in its financial statements.
Home Office Deduction
If you use a residential area as a part of your business, you might be compelled to fill out the IRS Form 8829 in determining the applicable tax deductions.
You complete this form if you are using your residence for business use. Its purpose is to calculate which home expenses are actually and exclusively used for business; thus, covered by tax deductions.
Methods To Determine The Home Office Tax Deduction
There are two ways to determine the home office tax deduction for self-employed contractors. According to the 2018 new tax law, these are simplified and regular methods.
The simplified method uses the area used for business as the basis for the computation. The allotted rate is $5 per square foot for every 300 square feet.
On the other hand, the regular method’s basis for calculation is the number of actual expenses incurred for a given tax period. This includes maintenance, mortgage, insurance, upkeep, and other expenses.
Ideally, the simplified version might be the better option for an independent contractor because the recording and application process is easier. However, in assessing both methods, the regular method may be preferable if the computation of the other generates a larger amount of tax deductions for self-employed contractors.
Section 199A Deduction
The one applicable tax deductions for self-employed contractors is the Section 199A deduction enforced last year. It provides a 20% tax deduction from net business income on top of your actual expenses. However, Section 199A does not apply to those earning more than $260,000.
Unlike those covered by payroll whose Medicare and Social Security taxes are paid by their employers, tax deductions for self-employed contractors amount to half of the amount. The same can be calculated by using the Form SE where half of which may be deducted to Form 1040. In order to avail for an additional self-employment tax, you may pay estimated taxes independently.
On top of your business income taxes, advertising and promotion expenses are also tax deductible. Advertising is spending on media promotions, ads, and marketing expenses for your business. Thus, the IRS allowed a tax deduction for advertising expenses so the burden of this expense is alleviated. Online workers can benefit from tax cuts on web hosting, printing of business cards, labor costs for marketing services, and contracting with video producers.
According to the latest 2018 tax deductions for self-employed contractors, those who work at home qualifies for cutbacks on their direct expenses. The entries covered by the rule includes insurance expenses, property taxes, maintenance expenses, and utilities.
There is, however, a limit to the deduction. One can only avail a maximum of $1,500 for home expenses entered on line 30 of Schedule C. The values may vary depending upon the method used in calculating the deduction. The option to choose the other may also be changed every taxable period.
Who Are Covered?
The home office tax deductions for self-employed contractors is either a lessee or a homeowner. Those covered can be condominium units, houseboats, single-family homes, and apartments. Unfortunately, temporary lodging does not fit the qualification nor does rent in a hotel room as an office. Those who operate studios or outdoor spaces are also covered provided that the use of the property is exclusive and regular.
Those who operate health care services or daycare centers are entitled to the tax deductions for self-employed contractors so long as the business operates by virtue of a certificate or public documents recognized by the IRS.
Moreover, the area specified must be the principal place of business where most of the operations take place, such as keeping financial records and other management functions.
If you rent a space that is not your residence, your rent expense is fully deductible. On the other hand, if you utilize your residential home as the principal place for business, only a portion of expenses are covered. Components covered are security systems, internet, phone, telecommunications costs, and gas used for commuting.
Like the previous deduction, supplies are also entries covered as a tax deduction under the Schedule C form. These include items exclusively utilized to operate your business such as office supplies.
Equipment and Maintenance Expenses
A business cannot run without the use of essential equipment. Thus, equipment expenses form part of the tax deductions of self-employed contractors. The items included are printers, calculators, computers, laptops, and other machines directly associated with your business operations.
Equipment may also be valued by considering its depreciation. Whenever the depreciation has been valued for several years, the Section 179 deduction is typically used. .
Maintenance is also tax deductible. Some owners outsource maintenance services to maintain the functions of their equipment. Therefore, the cost of actual repairs for the business items is also recognized as tax deductions for self-employed contractors.
However, if the owner performs the repairs without acquiring the services of another, the materials expense is the only tax deduction. These values must be reflected on Form 8829. Additionally, if your nature of maintenance is associated with the walls and/or roof of the office, the coverage is limited only to half of the value.
If you outsource the services, the cost of labor may also be deducted on Schedule C. If you acquire sub-contractors, their wages are also covered under the tax deductions of self-employed contractors.
Insurance and Retirement Expenses
Among those covered by the IRS are self-employed health insurance premiums. They are only deductible when the entity incurs a net profit for a particular year and must be specified on Schedule C. The same is applied to Form 1040 and subject to similar restrictions concerning insurance expenses.
However, only those plans covering one policy are recognized. Those applied for by other members of the family cannot be considered as among the tax deductions of self-employed contractors.
Policies that cover equipment and property are recognized by the IRS as an indirect expense deductible on Form 8829. When it concerns vehicle expenses, only a portion of the expenses can be covered and must correspond to the actual business mileage.
Homeowners who utilize their residences as the principal place of business are exempted from the insurance expense coverage. The formula to follow is:
- Indicating the actual vehicle expenses such as gasoline and other vehicle-related expenses
- Indicate the depreciation expense
- Multiply the value of business use percentage with the transportation expense.
The calculation also requires you to keep records of tolls and parking fees incurred for it to be recognized as a deduction on Schedule C.
Additionally, retirement plans whose contributions were sourced from your business’s assets are also reduce your tax in a period. These include entries pertaining to individual retirement accounts but are not recorded as deductions.
They are entered as tax credits for the first three taxable periods provided that each year yields net profits. Those generated for real estate interest are equally deductible including credit card interest and other financing entries.
Excluded As Deductions
Although the new law brought about greater financial benefits provided for by tax deductions of self-employed contractors, some components were rendered exempted. The following do not constitute as tax deductions based on the 2018 new tax law.
Before the Trump Tax Cut Act, tax deductions for small businesses and proprietorships were tagged at 50% for entertainment expenses utilized exclusively for business purposes. However, some businesses are not covered by the tax deduction anymore.
The nature of the expense may, however, render it deductible when it comes to entertaining a client with meals. Although the deduction rate may only be applied to 50% of the actual price of the food.
Those utilized for employees in the work site are only given a tax cut of up to 50% compared to the previous 100%. Nevertheless, food utilized for employees at company events and holiday activities is still covered within the 100% tax cut.
Another exemption to the tax deductions of self-employed contractors is bad debts. Although they are used directly in business operations, the same cannot be reflected for the taxpayer who uses the accrual method.
The Bottom Line
There are several benefits to earning income alone. Among these are several tax deductions of self-employed contractors which can significantly increase one’s financial capacity and rid of unnecessary expenses.
Hiring the services of competent tax advisors is the best way to maximize the deductions offered by the IRS to independent contractors. When a taxpayer is knowledgeable about these deductions, the cost-saving results allows you save more.
If time is of the essence and accounting details are too much to handle, hiring a professional is the best way to go. It may come at a cost but saving on time, effort, and preventing technical errors allow the self-employed contractors to focus their energy on growing their profitability. Here at LYFE Accounting, experienced tax accountants and Certified Public Accountants are ready to prepare your business tax returns. We maximize your cost-saving methods by adjusting updated tax deductions to your business expenses. Our keen attention to detail ensures accuracy and saves you time and money.