Guidelines for Self Employed Tax Deductions

Self-employed taxpayers may need to itemize to take the maximum deduction.

Owning a small business and working in a freelance capacity are alternative ways to earn a living without being an employee. But self-employed workers face special challenges when it comes to paying taxes. In general, self-employed taxpayers are liable for all of the income they earn, just like employees whose employers withhold taxes from each paycheck.

Definition

The IRS has special guidelines for determining which taxpayers qualify as self-employed and become eligible for self-employment tax deductions. Someone who doesn't have an employer but performs a service regularly and makes a profit falls into the trade or business category of self-employment. Sole proprietors are self-employed workers who run a small business alone. Finally, independent contractors perform services for the general public but remain under the control of a paying customer, who can set requirements about how the work is performed.

Types

All self-employed taxpayers have access to multiple tax deductions. Some of the most useful and lucrative deductions deal with running an office. Self-employed taxpayers with a home office can deduct a portion of their rent or mortgage, utility bills and furnishing costs. Office supplies, including computers used for work, are another type of deduction. Self-employed workers can also deduct the cost of work-related travel, including gas, meals and hotel stays. According to the IRS, self-employed filers may deduct half of their Social Security tax from their gross income.

Function

Tax deductions function to reduce how much a taxpayer owes the federal or local governments. Most deductions are listed on a special form as part of the tax return, such as a Schedule C that accompanies a federal income tax return. The tax code allows self-employed taxpayers to subtract the amount of deductions, up to a specified limit, from the taxable income listed elsewhere on the return. This means that a self-employed worker may only have to pay taxes on a small portion of that year's income. Reducing taxable income with deductions may also place self-employed taxpayers in a lower tax bracket, which means the tax rate, or percentage, is also lower.

Considerations

Self-employed taxpayers stand to save a great deal from deductions that are only available to the self-employed. But they can also claim many of the same deductions as employees who earn wages and pay income tax through the same federal and state taxation systems. For example, besides deducting a portion of a mortgage that applies to a home office, self-employed homeowners can also claim the full amount of their homeowners insurance and mortgage interest as an additional deduction. The standard deductions and dependent deductions that apply to employees also apply to self-employed workers.

Warning

The IRS sets limits on how much a self-employed taxpayer can deduct, These limits are based on income and listed in each year's tax instructions. Besides remaining within the limits, self-employed taxpayers need to carefully read the definitions of each term. For example, the IRS defines a home office as a space that has no other purpose besides performing work duties. A mixed-use space may not qualify for a deduction, and taxpayers who take liberties with deductions may face penalties and fines during an audit.

References

• Social Security Administration: If You Are Self-Employed
• Bankrate: A Dozen Deductions for Your Small Business
• IRS: Self-Employment Tax

Resources

• "Kiplinger"; Tax Breaks for the Self-Employed; Kimberly Lankford; January 2010