The Best Self-Employed Tax Deductions for 2021
As a small business owner, you probably won’t manage to reduce your tax liability as low as some of the infamously rich, but that doesn’t mean you shouldn’t try. There are several self-employed tax write offs you can use to save on your tax bill. The trick is to find them and then use them properly. Many deductions, particularly the home office deduction, are often misapplied while others are missed altogether. Here are some of the deductions you need to know about and the rules for using them the right way.
Qualified Business Income Deduction (QBI)
Love him or hate him, then-President Donald Trump did help small businesses by including the QBI in the 2017 Tax Cuts and Jobs Act. If your business is a pass-through entity, you may be able to lop 20% off the top of your business income when determining your taxable income.
A pass-through entity is one in which you pay the business taxes personally at the end of the year. Sole proprietorships, partnerships, limited liability companies (LLCs) and S Corporations can all serve as pass-through entities.
In 2021, you can take the qualified income business deduction if your total taxable income is less than $164,900 ($329,800 for joint filers). You might be able to take the credit or part of it if you make more, but things get a bit more complicated at higher income levels. As your income increases above the threshold, the IRS limits the types of businesses that qualify for the deduction and may reduce the amount of the deduction.
The home office deduction is a valid deduction for the self employed, but it’s one that often trips taxpayers up. Working from home is not enough to qualify you for this deduction. This tax break is meant as one of the self employed deductions — not an employee working from home deduction.
This distinction became particularly important during the COVID-19 pandemic when many people started working from home. Don’t asume that you can automatically take this credit due to the virus. If you started telecommuting due to COVID but are still considered an employee, check with us or another CPA firm before taking this one. Because it’s so often misunderstood and misapplied, know that taking this deduction could increase your audit odds. Make sure you take it properly and you’ll have no issues.
In order to qualify, you must also set aside a certain portion of your home exclusively for business. If you work at your dining room table by day and then eat dinner with the family at the table by night, your dining room fails the exclusive use test and doesn’t qualify for the deduction. You can, however, count space that you use for storing inventory and product samples.
If you do qualify, you can either take a standard deduction (currently $5 per square foot of office space), or you can calculate the actual percentage of square feet you’ve dedicated to working. You can also use this percentage to deduct part of your mortgage or rent. Don’t forget to deduct a portion of your utility bills based on this percentage as well.
They say it pays to advertise, and at tax time your ads can pay in more ways than one. In addition to getting your company noticed and building a customer base, advertising also offers you some tax savings. You can deduct your advertising costs at tax time, whether you printed fliers, ran television ads, or attended trade shows and other promotional events. You can also deduct the cost of hiring an advertising firm.
If you use your personal vehicle for business use, you may deduct mileage as a business expense. When you’re meeting with a client, dropping off goods or picking up office supplies, keep track of your mileage. At the end of the year you’ll have two options. One is to simply take a mileage deduction at the current flat rate, which is 56 cents a mile in 2021.
You can also calculate the cost of your actual car expenses, including maintenance, parking, tolls, registration and insurance. Just calculate the percentage of miles you drove for work and then deduct that percentage from your actual automobile expenses.
One of the few downsides of entrepreneurship is health insurance costs. Without a traditional employer to share the expenses with you, health insurance for yourself and your family gets costly in a hurry. You may be able to deduct the insurance premiums you pay for yourself, your spouse and any children who are under 27 at the end of the tax year.
There is a catch, however. If you are allowed coverage under your spouse’s insurance, you can’t deduct the premiums you paid for yours. This rule applies even if you turned down coverage under your spouse’s policy for good reason or if coverage would be more expensive under your spouse’s plan.
The business environment doesn’t stagnate, and neither can you. It’s important to keep up with the latest trends, technologies and best practices of your industry, which sometimes means continuing your education. To help you keep up, the IRS allows you to deduct education expenses including tuition, books, lab fees and other necessities.
In order to qualify, your expenses must come from study or training necessary to maintain or improve your current work-related skill set. The credit won’t help you if, for example, you currently work as a roofer but are going back to school so you can change jobs and become a legal consultant. Your education must relate to your current field to take the credit.
Without an employer to match your retirement account contributions, it’s a good idea to start contributing early to a retirement account like a solo 401(k). In 2021, you can deduct up to $19,500 of solo 401(k) contributions. Add another $6,500 to that number if you’re over 50. You may deposit money into your retirement account as it accumulates or treat yourself as your own employee and set up salary deferrals.
If you have business insurance, you have a tax deduction. Be it liability insurance, employee health insurance or worker’s compensation insurance, you can deduct the premiums you pay for your coverage. The same is true if you pay insurance on company-owned vehicles. (The way insurance is handled on the business use of your personal vehicle is detailed above.) This deduction is easy to take and appears as a line item on the Schedule C you’ll file at tax time.
You can’t run an office without office supplies. It turns out the IRS has you covered here too, making office supplies tax deductible. Technically, you should deduct these supplies in the year you use them, but the IRS will allow you to deduct them in the year you bought them instead. This way you need not inventory and track every pen, file folder and paper clip you use.
This works for the little things, but the IRS handles more expensive office supplies differently. Computers, office furniture and special equipment have useful lives that extend beyond one year. The IRS considers these items as assets. In that case, you must take your deduction over time using depreciation. You’ll still get to deduct the cost, but you’ll need to do it over time rather than all at once.
Credit Card and Loan Interest
In a perfect world, everyone would pay their full credit card balance every month and not pay any interest. The world is far from perfect, however, and many small businesses finance some purchases through credit cards and loans. If you can get them, loans are generally better because they tend to have a lower interest rate.
Whatever the source of your debt, be aware that you can deduct the interest you pay on your business credit card or loan. The easiest way to track the paperwork is to get a business card or have one personal card that you use exclusively for business. This way you won’t have to sit down with your credit card statement and endure the tedious process of figuring out which interest is yours personally and which is from the business.
Phone & Internet
Like the home office deduction, this one gets tricky. The easiest way to take this deduction is to install an internet service separate from the one your entire family uses. The same is true of your phone. Get a landline or a cell that you use only for business and deduct the expense come tax time.
This is a good suggestion, but it’s not a rule. If you and your business share an internet connection or telephone, you’ll have to determine what percentage of these items you use for your business and which you use personally. A lot of people just approximate this one, but you technically should have some kind of log or journal to back up your assertions on this deduction.
Remember the important caveat on this one: if your employer or a big client reimburses you for phone or internet service, you can’t take the deduction.
Business Travel Expenses and Entertainment
This is another deduction that gets some taxpayers in hot water with the IRS. You can absolutely use business travel expenses like airline flights, car rentals, hotels and taxis as business tax write offs. Rule changes now allow you to deduct the total cost of your meals, as well. You absolutely must deduct only expenses directly related to business travel, however. If you take your spouse, children or other people on the trip with you, you cannot count their expenses unless they are legitimate employees of the company.
Once you had to save receipts for every meal you ate while traveling for business. You still can if you like, but the IRS now allows you to use a standard daily meal allowance rather than tracking every crumb you eat while away.
The word entertainment also gets tricky here, too. Travel to a client who loves theater? You can deduct the cost of schmoozing them at their local dinner theater without dividing the expense between your meal and the entertainment. Took yourself to Disneyland as part of your trip since you were close by? Not a business travel expense. The same applies if you took your family on a vacation but happened to meet with a nearby client while you were in the area. To count for the deduction, the main thrust of your trip must be business-related.
Other Common Deductions
The write-offs mentioned above are all very common, but there are a few other deductions you should know about. We can’t possibly cover every potential deduction in a single blog post, but we do want you to be aware of and understand a few more of the options open to you. If you have questions on the deductions we’ve discussed or any of the deduction on this list, please don’t hesitate to ask us. These deductions include:
- Self employment tax
- Start-up costs
- Certain memberships and subscriptions
- Licensing fees
- Commissions and fees
- Tool repair and maintenance
- State taxes
- Contract labor and employee wages
- Employee benefit programs
- Legal and professional services
Clearly, there are a lot of tax deductions for small business owners to choose from. Here at Picnic Tax, we don’t want you to miss a single one. Our friendly, professional staff are happy to help you make sure you claimed every deduction you can and to verify that you did so correctly. We know you have better things to do with your time than explain yourself to the IRS, and we promise to do everything we can to make sure you don’t have to. Give us a call or email today to see what we can do for you.