16 Tax Deductions and Benefits for the Self-Employed

Legislators have written numerous lines into the tax code over the years to soften the blow of the extra costs that self-employed taxpayers must shoulder as they do business. The Tax Cuts and Jobs Act (TCJA), passed during the Trump administration, is one of the U. S. Congress’s most significant tax overhauls. The TCJA became effective with the 2018 tax year and it made several changes to self-employed tax deductions. Some of them are temporary and set to expire in 2025.

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). 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.

Eliminated or Changed Deductions

Some deductions have been eliminated or changed post-TCJA:

• Entertainment and fringe benefit deduction
• Employees’ parking, mass transit, or commuting expenses deduction
• Domestic production activities deduction
• Local lobbying expenses deduction
• The state and local tax (SALT) deduction is limited to $10,000, or $5,000 if you’re married and filing separately
• The 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

Tax laws are constantly changing and these provisions may be modified or extended at any point before 2025. Reviewing the most common self-employed taxes and deductions is necessary to keep you updated on any changes that are 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 these taxes. 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 income thresholds as of December 2023 are as follows:

• Married filing jointly: $250,000
• Married filing separately: $125,000
• Single: $200,000
• Head of household (with qualifying dependent): $200,000
• Qualifying widow(er) with dependent child: $200,000

The income thresholds for the additional Medicare tax apply to your combined wages, compensation, and self-employment income. You’d have to pay the additional Medicare tax of 0.9% on the $10,000 by which your joint income exceeds the $250,000 threshold if you have $100,000 in self-employment income and your spouse has $160,000 in employee wages.

The good news is that the self-employment tax will cost you less than you think because you can deduct half of it from your net income when you’re calculating your income tax. 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

The self-employment tax refers to Social Security and Medicare taxes, similar to the Federal Insurance Contributions Act (FICA) tax paid by an employer. It’s only a deduction for calculating that taxpayer’s income tax when they deduct one-half of the self-employment tax. It doesn’t reduce the net earnings from self-employment or reduce the self-employment tax itself.

You must pay the first 7.65% whether you’re self-employed or you work for someone else. You’re indirectly paying the employer portion when you work for someone else 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. They’ll claim 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 tax breaks. 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 that uses the square footage of your workspace in its calculation. The expenses you can deduct for your home office include the business percentage of rent, deductible mortgage interest, utilities, homeowners insurance, and repairs you pay for during the year.

Fifteen percent of your annual electricity bill becomes tax deductible if your home office occupies 15% of your home.

How To Calculate the Home Office Deduction

You have two choices for calculating your home office deduction: the regular method or the simplified option. You don’t have to use the same method every year.

The regular 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. Your home office must not be larger than 300 square feet to use the simplified option, and you cannot deduct depreciation or home-related itemized deductions.

The simplified option is a clear choice if you’re pressed for time or can’t pull together good records of your deductible home office expenses. But it’s calculated as $5 per square foot as of tax year 2023, the return you’ll file in 2024. So the most you’ll be able to deduct is $1,500 with a maximum of 300 square feet.

Calculate the deduction using both the regular and simplified methods to determine which will give you the greater benefit. Calculate the deduction using IRS Form 8829: Expenses for Business Use of Your Home, if you choose the regular method.

3. Internet and Phone Bills Deduction

You can also deduct the business portion of your phone and Internet expenses. The key is to deduct only the expenses that are directly related to your business. For example, you could deduct the Internet-related costs of running a website for your business.

You shouldn’t deduct your entire monthly bill, including both personal and business use, if you have just one phone line. 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

You can deduct all your health, dental, and qualified long-term care (LTC) insurance premiums if you’re self-employed, you pay for your health insurance premiums, and you’re not eligible to participate in a plan through your spouse’s employer.

You can also deduct premiums you paid to provide coverage for your spouse, your dependents, and your children younger than age 27 at year’s end, even if they aren’t dependents on your tax return. 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 can’t 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, that desk lunch is not tax deductible.

The standard meal allowance is the federal meals and incidental expenses (M&IE) rate, updated every fiscal year effective Oct. 1. The rate and M&IE breakdown can be found on the U.S. General Services Administration (GSA) website. Meals can’t be deducted if they’re not separately identified on the receipt.

6. Travel 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) to qualify as a tax deduction. You should have a specific business purpose planned before you leave home, and you must engage in business activities while you’re on the road, such as finding new customers, meeting with clients, or learning new skills directly related to your business.

Keep complete and accurate records and receipts for your business travel expenses and activities because 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, either. You’ll still be paying the bulk of your business travel costs so keeping them reasonable is in your interest. Your travel expenses for business are 50% deductible in 2023, the year for which you’ll file a tax return in 2024.

7. Vehicle Use Deduction

Your expenses are tax deductible when you use your car for business, but make sure to keep detailed records of each trip’s date, mileage, and purpose. 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 rate is $0.655 per mile in 2023, the year for which you’ll file a tax return in 2024. 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.

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 to use the actual expense method. Your deduction would be $300 if you spent $3,000 on car operating expenses and used your car for business purposes 10% of the time.

8. Interest Deduction

Interest on a business loan from a bank is a tax-deductible business expense. The business portion of the loan’s interest expense is allocated based on the allocation of the loan’s proceeds if the loan is used for both business and personal purposes.

Track the disbursement of funds for various uses if the entire loan isn’t used for business-related activities. Credit card interest isn’t deductible when you incur it for personal purchases, but it’s deductible when the interest applies to business purchases.

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 wouldn’t be specific enough to be considered a business expense for most businesses, but a subscription to Nation’s Restaurant News would be deductible if you’re a restaurant owner. 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.” But the IRS does make exceptions for groups that it considers to not exist for entertainment purposes, such as:

• 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. Taking a course called “Real Estate Investment Analysis” to brush up on your skills would be tax deductible if you’re a real estate consultant, but a class on teaching yoga would not.

11. Business Insurance Deduction

You can deduct your premiums for insurance to protect your business, such as fire insurance, credit insurance, car insurance on a business vehicle, or business liability insurance. 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

You can deduct the amount that you pay for rent if you rent an office space that’s not in your own home. You can also deduct amounts paid for any equipment that you rent and the expense of having to pay a fee to cancel a business lease is also deductible.

13. Startup Costs Deduction

The IRS usually requires that you deduct major expenses over time rather than all at once. They’re treated 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. You can also deduct up to $5,000 more in organizational costs, such as state filing fees and legal fees if you set up a corporation or LLC for your business.

Professional fees to consultants, attorneys, and accountants 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. A sign advertising “Holiday Toy Drive Sponsored by Robert’s Hot Dogs” would be tax deductible.

15. Retirement Plan Contributions Deduction

The deduction for self-employed retirement plan contributions is incredibly worthwhile. Contributions to simplified employee pension individual retirement accounts (SEP-IRAs), savings incentive match plans 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.

You could feasibly contribute as much as $22,500 in deferred salary for the 2023 tax year and $23,000 in 2024. You can make catch-up contributions of $7,500 for a total of $30,000 in 2023 ($30,500 in 2024) if you’re age 50 or older.

Your total maximum contributions to a self-employed 401(k) can’t exceed $66,000 for 2023 and $69,000 for 2024, not counting catch-up contributions of $7,500 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 deductions for books, professional instruments, and equipment, as long as they’re used within the year. You must generally recover its cost through depreciation, however, if an item’s use extends beyond one year.

You may still deduct the cost of certain supplies that you keep on hand on a regular basis from year to year 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.

The Bottom Line

There are more deductions available than those that are 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. You can deduct a small amount of the cost each year over several years.

Ask yourself, “Is this an ordinary and necessary expense in my line of work?” if you’re ever unsure whether a cost is a legitimate business expense. This is the same question the IRS will ask when examining your deductions if you’re audited. Don’t take the deduction if the answer is no. Seek professional help with your business tax return from a certified public accountant (CPA) or other credentialed tax preparer if you’re unsure.