Updated for tax year 2023.
As a self-employed taxpayer, do you ever envy your traditionally employed friends at tax time? Having your own business as a freelancer or independent contractor definitely increases the record-keeping you must do for tax purposes. And when you’re digging through all your self-employed income tax records and business receipts, it’s easy to wish for the days when you only had to enter taxable income from a W-2form.
However, as a self-employed individual, you get some tax breaks that your employed friends don’t. For one thing, you can deduct business expenses — these expenses even reduce your Social Security and Medicare tax, which you pay in the form of self-employment tax.
Here are 14 self-employed tax tips that can make tax time less painful and help you take advantage of some of the tax benefits of working for yourself.
1. Estimate your business income.
Unless you estimate your business income,tax planningis guesswork at best. It’s essential that youfind out where you stand tax-wise before you start taking other tax planning steps. For example, you don’t want to make expenditures in a year when you don’t need the deduction as much. If you expect to be in a higher tax bracket this year or next, you’ll want to take as many deductions as possible in the year you are subject to the highest tax rate. Estimating your business income can help you plan how to time your business expenses so they benefit you the most.
2. Time your business income.
Income is generally taxable when it is available to you. While you can’t postpone income simply by not cashing checks, you have some control over when you bill your customers and receive payment for your services. Plus, one type of income you have more control over is your capital gains. For instance, you might decide to sell assets at a gain before or after the end of the tax year, depending on what would better benefit your tax situation.
3. Time your business expenses.
There’s typically a surge in business equipment sales at the end of the year — and it’s not entirely because computers and printers are a popular holiday gift.
Business expenditures are counted as made in the year you purchase them, even if you use a credit card or other deferred payment plan and don’t pay for them until the following year. For example, if you buy a business asset on Dec. 31, you can start depreciating it almost immediately when filing your next tax return the following year. You may even be able to take aSection 179 deductionand expense the entire cost of the asset in one year.
One thing to note — don’t buy a bunch of inventory or supplies that will be part of the inventory before the end of the year unless you really need them. This is because you generally don’t deduct the cost of goods sold until you sell the product.
4. Make the most of medical insurance deductions.
If you are ineligible for health insurance benefits through an employer, you can qualify to deduct health insurance premiums you bought for yourself, your spouse, and your dependents as an adjustment to income. This includes premiums for long-term care insurance. The policy does not need to be in the business name — it’s deductible even if it’s in your name.
5. Keep your business structure simple.
Unless you need to form a partnership or a corporation for business reasons, it may be best to stick with a sole proprietorship and report your business income and expenses on your personal income tax return using Schedule C. It’s the simplest way to file, and there’s nothing you have to disband if you move on to something else. If you’re a sole proprietor looking for legal protection, it’s always best to consult your lawyer, who can help determine if you may also want to get liability insurance or form a single-member limited liability company (LLC).
6. Automate your record-keeping.
Small business record-keeping doesn’t have to be hard these days. In fact, shoeboxes or grocery bags full of crumpled receipts should be a thing of the past. Instead, you can use various available personal finance software to track everything for you. Often, these apps can easily sync with your bank accounts, making it a stress-free way to track your income and expenses all in one place. Automatic record-keeping not only saves you time, but it’s less prone to mistakes, too.
7. Understand itemized deductions vs. business deductions.
By taking a business deduction instead of an itemized deduction, you reduce your adjusted gross income (AGI) and your self-employment tax. Whenever possible, it’s best to deduct an expense or a portion of an expense as a business expense rather than an itemized deduction, as this generally increases your tax savings.
8. Pay your kids.
If you’re a parent, you can deduct the amounts you pay your kids to work in your business. Kids generally pay less taxthan you would since they are likely in a much lower income tax bracket.
Say you hire your child for your business, and they are under 18 (or under 21 for domestic work). In this scenario, you don’t need to pay or withhold FICA tax or federal unemployment tax. You can also deduct the payments made to your child — just make sure the amount you’re paying them is reasonable and they are actually doing the work. There’s no need to worry about the “kiddie tax” in this instance either, as the kiddie tax does not apply to earned income.
9. Take a home office deduction.
If you have a qualified home office, you can deduct office supplies and some of your otherwise nondeductible expenses, such as a portion of your home insurance, utilities, and rent or mortgage payment. To simplify this process, the IRS also allows you to take thesimplified home office deduction, where you deduct a flat rate per square foot. This method allows you to take advantage of small business tax perks without the stress of lengthy calculations and record-keeping.
10. Avoid the IRS hobby trap.
If the IRS deems your business to be ahobby, you’ll have to report any income you made from your hobby, but you won’t be able to write off hobby expenses like you would business expenses.
To ensure your business doesn’t get classified as a hobby, it helps to have made a profit in three out of five consecutive years. But even if you haven’t done this, you may still prove to the IRS you are a for-profit business if you operate in a businesslike manner and keep good records.
On the other hand, if you make a small amount of income every year from a hobby, such as breeding dogs or carving lawn ornaments, you may want to keep it that way. Sure, you won’t be able to deduct your expenses, but hobby income is also not subject to self-employment tax, which otherwise would be 15.3% of your net income from the operation.
11. Turn charitable contributions into business expenses.
Under normal circ*mstances, you can’t deduct charitable contributions on your Schedule C. However, the donation can be considered a business expense if you give money to charities in exchange for something in return (like advertising for your business). This method will give you a greater tax benefit than a typical itemized charitable donation deduction. Just be sure to keep detailed records of what you received in return for the donation.
12. Increase your self-employed retirement contributions.
As a self-employed small business owner, you have the option to fund your own retirement plan. While contributions to typical IRAs are limited, you can contribute significantly more to a retirement account by opening something like a SEP IRA. There is no company size requirement for a SEP IRA, and contributions to one are tax-deferred, so you won’t pay federal income tax until you make a withdrawal. In 2023, you can contribute up to 25% of your total compensation or $66,000 (increasing to $69,000 for 2024), whichever amount is lower.
13. Track all business mileage.
Whether you take the standard mileage deduction or you keep track of actual expenses for gas, oil, etc., you must have good records to deduct vehicle expenses. Your records must include mileage driven, the business purpose, and the date. Make sure you count every trip to the post office or to meet a client — those miles add up. To estimate your mileage deduction, try out our Mileage Reimbursem*nt Calculator.
14. Check out your liability for the alternative minimum tax (AMT).
Tax planning usually means finding more deductions and postponing income, but not always. You might want to do the opposite if you could lose certain self-employed tax deductions because of the alternative minimum tax.
Thealternative minimum taxis a parallel tax system to our standard tax system — it just uses different tax rates. It also calculates your tax liability without the benefit of certain tax breaks, such as deductions for state and local taxes (like real estate taxes) or certain business items. You can check out IRS Form 6251 for more details on which tax breaks would be impacted by the alternative minimum tax.
You may trigger the alternative minimum tax if your income is above the annual AMT exemption amount. AMT rates are 26% or 28%. Basically, if your income tax calculated by AMT rules is greater than your tax under standard income tax rules, you pay the excess as AMT tax.
Sound confusing? This is where tax preparation software like TaxAct® comes in handy — once you input your information, we’ll crunch the numbers for you to ensure your taxes are calculated correctly.
