The Ins and Outs of being Self Employed – Part 1: Deductions

We would all love to be our own boss, right?  While it may sound great, keep in mind that doing so can introduce a lot of complexity to your tax situation.

We hear questions from clients on this all the time, such as: What can I deduct? What is deductible for meals and travel? Do I need to track my mileage? Can I deduct my home office expenses?

Deductions can reduce the income that is subject to income tax and self-employment tax.  Below are common expenses incurred by self-employed individuals:

• Advertising/Marketing
• Auto expenses
• Depreciation
• Insurance
• Meals
• Office expenses and supplies

Let’s review a few of the most popular items:

Auto Expenses

You can generally figure the amount of your deductible car expense by using one of two methods: the standard mileage rate method or the actual expense method.

• Standard Mileage Rate: For 2021 this is 56 cents per mile. The election to use the standard mileage rate must be made in the first year you use a car for business. In subsequent years, you are allowed to switch between the standard mileage rate and actual expenses (discussed next).
• Actual Expenses: Under this method, you deduct the portion of your actual costs incurred to operate the car in your business. Include gas, oil, repairs, tires, insurance, registration fees, license fees, and depreciation (or lease payments). All expenses need to be attributable to actual business miles driven. Once this method is used, you need to continue to use it while the vehicle is still being driven for business.

Other car expenses for parking fees and tolls attributable to business use are separately deductible, whether you use the standard mileage rate or actual expenses.

Depreciation

Depreciation allows you to deduct a percentage of the cost of an asset during each year of what the IRS considers its useful life. Most IT assets, like computers and computer-related peripheral equipment, are classified as five-year property. Office furnishings are considered seven-year property.  However, if you have a capitalization policy in place, you can deduct the cost of any asset under a certain amount stated in the policy (usually up to $2,500).

Meals

You can still generally deduct 50% of the cost of business-related meals. You can deduct 100% of the cost of business meals provided by restaurants in 2021-2022.

Health Insurance

Self-employed individuals can deduct their health insurance premiums “above the line.”  This means that the deduction is not limited to 7.5% of your adjusted gross income as an itemized deduction.  The health insurance deduction includes the self-employed individual as well as their spouse and any dependents that are on the policy.  This also includes dental insurance.

Home Office

If you conduct your self-employment work from home, you are able to deduct costs related to your home office. To qualify for the home office deduction, you must have a specific area in your home designated for working, and you must refrain from using it for non-business purposes. Two options are available for claiming this deduction:

• The Regular Method requires you to allocate expenses of the overall home to your home office based generally on square footage. You are also allowed to depreciate a portion of your home related to the home office.
• The Simplified Method is $5 multiplied by the square footage of your office space, with a size limit of 300 square feet. This means the maximum annual deduction under the simplified method is $1,500.

For additional considerations, please reach out to Sonja Pettit, CPA, Associate Director, or contact our Tax Solutions Team at Mahoney to be of help to you in any way.