Tax deductions for the self-employed are not necessarily self-evident. They're found on a wide variety of different tax forms and apply in different situations. While Schedule C is an important tax form for the independent contractor, you should be aware of self-employment deductions that may be available in other parts of your income tax return, too.
1. Half of Your Self-Employment Tax
When employed, your employer pays half your Medicare and Social Security taxes, and you pay the other half through payroll taxes. When you are self-employed, you must pay all of it as self-employment tax. However, as your own employer, you are entitled to deduct half of those taxes. That deduction, which you'll calculate on Schedule SE, affects your adjusted gross income.
Self-employment tax can be a big cost for an independent contractor. Knowing how self-employment tax is calculated is important when considering employment versus contracting.
2. Use of Your Home Office
Taking a home office deduction can be an important self-employment deduction, but there are many IRS rules regarding it. In general, deductible home office expenses are related to how you use your home office. They're also partially deductible in proportion to the amount of space the office takes up within the home and the amount of business you do there.
To calculate the deduction for use of your home office, use Form 8829. The deductible amount is then entered on your Schedule C, which you'll file along with your Form 1040. You can deduct home office expenses in one of two ways: Using the simplified method of $5 per square foot of your home office, or using the percentage of your home square footage used for business multiplied by your indirect expenses.
3. Rent and Mortgage Interest
If you rent or own facilities that you use in your business, rent and mortgage interest are deductible on Schedule C. However, this self-employment deduction is limited to space outside your home. Home office deductions of rent and mortgage interest are only partially deductible.
4. Utilities, Internet, and Phone Costs
If you own or rent office space outside your home, utilities are fully deductible. For home offices, these are mostly considered indirect expenses and are only partially deductible. Utilities might include gas, electric, and security systems.
Phones used for business are legitimate self-employment deductions. This includes cell phones for business use and second phone lines in your home office. While you cannot deduct the base cost of your home phone line, you can deduct the cost of business calls made on it. These are deductible on Schedule C.
The supplies you use to run your business are deductible on various lines of Schedule C. Consumable office supplies like toner, paper, and envelopes are deducted in Part II of Schedule C. (Equipment such as computers, cameras, printers, and calculators are deducted separately.) Be sure to keep these items separate from those you have for personal use and organize your receipts.
These types of incidental supplies are deducted separately from the raw materials you use if your business is one that makes and sells goods. See Part III of Schedule C for deducting the cost of raw materials and merchandise.
Office equipment, tools, or machinery are deducted on line 13 of Schedule C, or the "Depreciation and Section 179" line. First, use Form 4562 to calculate depreciation on your assets. You'll use this form whether you are depreciating the equipment over multiple years or in one year with a Section 179 deduction.
7. Repairs and Maintenance
Repairs and maintenance deductions include the cost of actual repairs as well as service contracts for business equipment and your office. These are taken on Schedule C. If you did the work yourself on the repair, though, you cannot deduct the labor cost—only materials. Deductions for repairs to a home office are calculated on Form 8829. If a repair is made on another part of your home that affects your home office (for example, the furnace), it is likely an indirect expense and only partially deductible.
8. Retirement Plans
When you are employed, contributions to retirement plans (within the established limits) reduce your taxable income on your 1040, even if you don't itemize deductions. The same is true for the self-employed. You can establish individual retirement accounts (IRAs), such as SEP or SIMPLE IRAs, for yourself and your employees. If you establish a new retirement plan for employees, you may be eligible for a tax credit for the first three years. For yourself (but not your employees), you may use a traditional IRA to make contributions.
9. Self-Employed Health Insurance Premiums
To deduct self-employment health insurance premiums for yourself and your family, you must have a net profit on your Schedule C, and you must not be eligible for coverage on another plan (such as your spouse's plan). Other restrictions for self-employed health insurance deduction also apply. This adjustment to income is recorded on your 1040.
10. Other Insurance
Other insurance can include business, property, liability, malpractice, worker's comp, and any other business insurance. If you have a home office, a portion of your homeowner's insurance is deductible as an indirect expense on Form 8829. If you use a personal vehicle for business, you may deduct a portion of auto insurance (if you're not just deducting the standard mileage). These are taken on Schedule C, except for the homeowner's insurance, which is calculated on Form 8829.
11. Employee Wages and Benefits and Payments to Contractors
You can deduct the cost of labor paid to independent contractors and employees on Schedule C. However, these self-employment deductions are on separate lines: contract labor (Line 11) and salaries and wages (line 26). If you provide benefits to your employees, such as health insurance and life insurance, these are also deductible. Remember, though, your own health insurance premiums are deducted separately.
12. Taxes and Fees
Just as you may deduct your employer portion of Medicare and Social Security for yourself, you can deduct these taxes for your employees. However, unlike your own taxes, employees' payroll taxes are deducted on Schedule C. Additionally, you can deduct sales tax paid, unemployment taxes, and fees for licenses and permits. Property taxes on real estate used exclusively for business purposes are deductible. The property tax on a home in which you have an eligible home office is partially deductible.
Just as mortgage interest for real estate used for business is deductible, other types of interest are deductible as well. This includes financing costs and credit card interest. Keep separate credit cards for your business to make this interest easy to calculate. You cannot deduct interest from personal purchases, only business expenses. This is deducted on Schedule C.
14. Advertising, Promotion, Dues, and Subscriptions
These might include the cost of advertising, websites, business cards, brochures, mailings, memberships, and professional journal subscriptions. Most of these would be deductible on line 48 of Schedule C.
15. Business Travel
Business travel expenses must be "ordinary and necessary" if you wish to deduct them. The purpose of the trip should be primarily business, not personal. And expenses for family members traveling along are not deductible. Deductible travel expenses may include transportation, car, lodging, meals, and incidental costs.
Note that while employees use Form 2106 to report business travel expenses, self-employed persons report it on line 24a of Schedule C. As per the Internal Revenue Service, for the 2020 tax year, the standard mileage rate for business-related driving is 57.5 cents per mile. The rate will be 56 cents per mile for 2021.
Meal expenses for business may be deductible for 50% of any unreimbursed cost. Report them on line 24b of Schedule C. Under the 2017 Tax Cuts and Jobs Act, entertainment is no longer a deductible expense.
17. Transportation and Auto Expenses
Commuting costs are not deductible. However, if your home office is your principal place of work, traveling to other sites where you do business may be deductible. When deducting automobile expenses (Schedule C, Line 9) you can either take the standard mileage deduction or you can calculate actual expenses and depreciation and multiply that by your business use percentage.
Either way, you need to keep accurate records of your business vehicle use. Parking fees and tolls should also be added to these figures before entering them on Line 9. Depending on your particular situation, you may need to file Form 4562.
18. Professional Services
Legal fees and tax preparation costs for your business are deductible on Schedule C. The cost of having your personal income tax prepared is not deductible, though, so have your accountant itemize his or her fees.
19. Business Bad Debts
To write off a business's bad debts (an unpaid debt owed to you and incurred in business operation), you must be using the accrual method of accounting, which means you report your income as it is earned, not as it is paid. Because most small companies, independent contractors, and freelancers use the cash accounting method, this is not a common self-employment deduction—but it's useful to know nonetheless. Bad debts are deducted on Schedule C.