Many people who venture out on their own to start a business find that the tax rates are high for the self-employed. And, 15.3% does seem high, but you get to deduct half of your self-employment taxes from your net income. The self-employment tax works like a business expense and you are allowed to deduct it accordingly. In addition, you don't pay self-employment taxes on your gross income. You only pay self-employment tax on your net business income - and then on only 92.3% of it.
On top of that, there are some very reasonable deductions (below) that you can take in order to reduce your tax burden. Just be sure you maintain accurate records of spending and that you truly qualify before taking any deduction. Most of the deductions that follow make our list of top ten IRS audit triggers, so document everything.
Health Insurance
Self-employed persons who pay their own health insurance premiums, and were not eligible for coverage through an employer or spouse's employer, can deduct all of their health and dental insurance premiums. This includes coverage for a spouse and dependents.
Meals and Entertainment
You can deduct half of the cost of meals and entertainment when business related. Careful records of who attended, the purpose of the meeting and how it related to business are essential. Be careful here. If your expenses in this category seem out of proportion to the size of your business, or simply inconsistent with the kind of business you do, you might be asking for trouble.
Telephone & Internet
Even if you don't claim the home office deduction, you can still deduct the cost of your business phone and broadband costs. Even if the phone and internet connectivity are shared for personal use throughout the home, you can deduct your estimated percentaqge of business use. If you have a dedicated line for business, or business dedicated internet connection, the full cost is deductible.
The Home Office Deduction
One of the more complicated deductions in the entire tax code, you qualify for the home office deduction only if you have a workspace that is used only for business. It can be a den, a spare bedroom or an addition you've built. That doesn't matter. What does matter is that you use that space regularly for business and only for business. If you qualify, you can deduct a percentage of the rent or mortgage, utilities, property taxes, and insurance your pay throughout the year.
Because this deduction is a trigger for close scrutiny by IRS agents, we srongly suggest you talk to your CPA to be sure you qualify and to learn exactly how to document your claim. If you qualify, don't be afraid to claim it. But know how to figure your claim and how to defend your claim if the need arises. For that, your CPA knows best.
Business Vehicle
The tax code allows you to deduct business use of a vehicle, but compliance means exacting record keeping. Expect close scrutiny of your return if you claim business use of a vehicle, because the IRS sees frequent abuse in this area.
There are two ways to approach these deductions. First, simply deduct the standard mileage rate as determined by the IRS for a given year. Using the standard mileage rate is the easier method, requiring less record keeping. Simply record your mileage, purpose and dates and ultiply mileage by the current rate to calculate your deduction. The second method, the expense method, means calculating the percentage of driving you did for business only and getting to a cost for business use by multiplying that percentage against the calculated total cost of operating the vehicle.
Apply these deductions to reduce your net income and your taxable income goes down. Remember, you pay 92.3% of your net, not your gross. Just be aware that deductions for the self-employed rank high among the most abused deductions for any tax year. You'll want to know exactly what the qualifications and restrictions are, and exactly what kind of documentation you'll need. Consult your CPAto be sure your deductions are legally compliant and audit proof.
