Simplified Home Deduction, and Other Tax Considerations for Self-employed Individuals
Considering how many of us worked from home last year, the home office deduction is presumably going to help a lot of taxpayers save a little money this year. It’s one of several tax benefits available to self-employed individuals. If you’re self-employed and work out of your home, there’s a good chance you can reduce your taxable income with the home office deduction. Calculating this deduction can be complicated, but the simplified home deduction provides a shortcut that works for some taxpayers. It’s just one of many tax considerations you should know about if you’re self-employed.
The Simplified Home Deduction
Any self-employed taxpayer may qualify for a home office deduction if they meet two criteria, per the IRS. First, the taxpayer must use part of the home exclusively for conducting business on a regular basis. Second, the home must be the taxpayer’s primary place of business.
To take advantage of the home office deduction, you’ll need to measure the size of the area in your home that you use exclusively for business purposes. From there, you can use one of two methods to calculate how much you can take for the home office deduction.
The regular method requires you to estimate your real costs associated with maintaining your home office. Only certain kinds of expenses are deductible. Let’s say your home office takes up 10 percent of your home. Using the regular method, you would figure out your deduction by calculating 10 percent of what you spent on utilities, mortgage interest and other allowable expenses.
The simplified home deduction was introduced in 2013 as an easier alternative. To take the simplified home deduction, multiply the number of square feet devoted to your home office by the flat rate of $5 per square foot. The IRS only allows the simplified home deduction for up to 300 square feet of home office space, so the maximum allowed deduction is $1,500.
The simplified home deduction is certainly easy to calculate. Using this method saves you from having to pore over the records of all your home expenses from the last year. It’s not always the appropriate choice, however. If your home office is larger than 300 feet, or if you had a lot of home-office expenses last year, using the regular method may allow you to deduct more than the $1,500 maximum available using the simplified method.
Take Advantage of Other Deductions
One of the benefits of being self-employed is your access to a number of special deductions that aren’t available to full employees. Here are just a few of the potential deductions that could help you minimize your tax bill.
• Health insurance premiums: If you pay for your own health insurance premiums and aren’t eligible for an employer-sponsored health plan, you may be able to deduct those premiums at tax time. The deduction is calculated on a month-by-month basis, so if you were on a company health plan for three months and self-employed for nine months, you may be able to deduct nine months’ of premiums. As long as you’re self-employed and have a net profit, the IRS lets you use this deduction to lower your taxable income.
• Vehicle deductions: If you used your vehicle for business this year, you may be eligible to deduct some of the related expenses. Like with the home office deduction, the IRS allows two methods for calculating a vehicle deduction. You can track your actual vehicle expenses and deduct costs including gas, insurance, repairs and lease payments. Or, you can multiply the standard mileage rate ($0.575 for tax year 2020) by the number of miles you drove for business purposes.
• Continuing education deductions: Any continuing education that helps you build skills for your current work, or is required by law in order to keep doing your job, may be tax-deductible if you’re self-employed. Deductible expenses may include tuition, books, travel and other related costs.
More Tax Considerations for Self-Employed Individuals
Navigating your tax obligations can be overwhelming when you’re self-employed, especially if you’re new to it. Self-employment taxes and quarterly payments are significant differences between being paying taxes as a W2 worker and as a self-employed worker.
Currently the self-employment tax rate is 15.3%, which breaks down to 12.4% for Social Security and 2.9% for Medicare taxes. Employers split the cost of these taxes with their employees, but as a self-employed individual, you’re responsible for the full amount. Self-employed workers are also generally required to pay estimated tax payments four times a year. Failing to make quarterly payments may result in penalties.
This year, another consideration is that the pandemic and its related relief laws may affect your tax prep if you were self-employed during 2020. For example, the CARES Act included a provision allowing self-employed individuals to defer some self-employment taxes. Depending on what decisions you made during 2020, you may need to account for them on your 2020 tax returns.
Finally, self-employed individuals should know about the many tax-advantaged retirement plan options available to them. You may be able to save on taxes and save more for retirement than you would using employer-sponsored plans. Make sure you’re considering options like the self-employed 401k and SEP IRA as part of your tax planning strategy going forward.
Our advice for self-employed individuals? Don’t attempt to figure everything out on your own. Unless you’re a tax pro, you may not know about all of the deductions available to you, or how to get the most value out of those deductions. Plus, if you’re new to filing taxes as a self-employed individual, we want to make sure you don’t miss anything that has to be fixed later. No one needs extra attention from the IRS.
Sachetta Callahan works with each client to meet their individual tax needs. Whatever your career looked like last year, we can help you meet your tax obligations this year. Let us make the tax process as quick and painless as possible, so you can get back to running your business.
George Liakakis is a Certified Public Accountant and holds a Master’s Degree in Accounting from the University of Massachusetts Lowell. George has been working in public accounting for 7+ years with two different firms ranging in sizes from local to national. He joined our team in 2016 and will be focusing on both business and individual taxation.