Self-Employment

Self-employed individuals are those who work for themselves, are partners in a partnership, or are members of a limited liability company (LLC). In this scenario, the self-employment taxes are calculated when the taxpayer files their personal tax return, which includes Social Security and Medicare taxes, similar to the Social Security and Medicare taxes withheld from an employee's paycheck.

If you are generating a profit, then you must calculate the self-employment tax on this amount. If you incur a loss, then you cannot claim an itemized deduction for the loss on Schedule A (Form 1040). The self-employment tax rate is 15.3% (12.4% for Social Security plus 2.9% for Medicare). Self-employed individuals pay both the employee and the employer portions of their Social Security and Medicare taxes.

Self-employed individuals are not eligible for the same tax benefits as salaried employees. However, they can avail of certain tax deductions and credits to reduce their income taxes so they can save on the money they would have paid under a salary-based system.

Self-employed individuals also need to plan ahead as there is no such thing as retirement benefits like those available to salaried employees on retirement or for medical insurance costs. This may make it more difficult for them to live comfortably in retirement. This is where you can see the tax planning benefits your long-term goals.

Self-employed individuals must pay their estimated taxes quarterly for their personal tax obligations. Business owners with employees have payroll tax obligations as well. In the next paragraphs we will go through multiple tax deductions that may help lower your federal income tax and your self employment tax. Some of these may be recurring tax strategies that will benefit you year after year. Some others are a one time strategy move. Regardless of the frequency of the strategies, you can get a new tax plan for self employed for this tax year.

<a href="https://www.vecteezy.com/free-photos">Free Stock photos by Vecteezy</a>

Home Office

Home office deduction is considered to be one of the most popular tax deductions.

However, it is important to make sure that the home office meets all IRS criteria before claiming it. For example, there are certain requirements for the area that needs to be designated as home office. It needs to be used exclusively and regularly for business purposes.

The size of that area also matters, but it doesn't need to be an entire room or space. It can be part of a room or any other space in your home which you use exclusively and regularly for business purposes.

Apart from having a storefront or office for your business, you can also set up a home office for your company as a business owner. With the simplified option, you can take a $5 deduction per square foot of space dedicated to your home office. For the standard option, you deduct an amount equal to a percentage of the interest you paid on your mortgage, home depreciation, utilities, homeowners insurance, and repairs you made to your house.

Depending on your situation, you may want to calculate what will be your most beneficial option. Taking the standard option will require you to include the depreciation recapture when calculating your profit on the sale of the home if you later decide to sell it. Depreciation recapture is not calculated when you use the simplified method.

Health Insurance Premiums

One of the most important goals for self-employed individuals is to save money on taxes. One way they can do this is by purchasing health insurance premiums for themselves and their family members.

Self-employed individuals are not eligible for many of the tax breaks that other taxpayers enjoy, such as health insurance premiums paid by an employer. However, they can purchase insurance on their own and deduct the cost from their income taxes.

When you file your taxes, you can deduct the premiums you paid for your health insurance plan. You do not need the policy to be registered in the name of your business. In addition to your own premiums, you can deduct the premiums you pay for your spouse and dependents.

If you have a high-deductible health plan, you can also deduct your contributions to a health savings account (HSA). Additionally to getting a tax deduction when you contribute to the HSA, medical expenses paid through the HSA are tax-free. When used for non-medical expenses, HSA funds are taxed.

Vehicle Use

The use of vehicles is an important tax deduction for business owners. An automobile, motor home or other vehicle may be used in or for the production of income if it is held primarily for use in the production of income. This includes, but is not limited to, trucks, vans and automobiles that are used to deliver products or services.

Two options exist for deducting your business-related vehicle expenses. The simplest method is to claim the standard mileage rate. Your vehicle deduction is calculated by multiplying your total annual business miles by the standard mileage rate, which is set by the IRS each year.

As a second option, you can use the actual expense method. You need to calculate the percentage of driving that you did for business throughout the year, along with the total operating costs of your car, such as gas, oil changes, registration fees, repairs, and car insurance.

Business Insurance

The premiums you pay for business insurance are one of the tax deductions you can claim to protect your business. There are several types of insurance, including fire insurance, credit insurance, car insurance, worker's compensation insurance, general liability insurance, and errors and omissions insurance, among others.

Some people don't like paying insurance premiums because they consider them a waste of money if they never have to make a claim. Nonetheless, these premiums can be deducted and you can protect your business at the same time.

Maximize Retirement Contributions

As a small business owner, you may have access to special retirement savings options, such as SIMPLE IRAs, SEP IRAs, and Solo 401(k) plans. All qualified plans are designed to allow for tax-efficient retirement savings. Depending on the plan, tax-free investment earnings (Roth) or tax-deferred savings and investment growth (traditional pre-tax) are available; in either case, the tax benefit continues. The withdrawal of funds before the age of 59.5 may be subject to an early withdrawal fee and can also trigger tax consequences.

Self-employed individuals typically have five retirement plans: traditional IRAs, SIMPLE IRAs, SEP IRAs, individual 401(k)s, and defined-benefit plans. The savings range from $6,000 to nearly $300,000 per year under these plans. Consult with your tax professional if you have more questions.

Traditional or Roth IRA Plans.
1. This is a good option for saving a modest amount. Your IRA is not associated with your employer, so you can continue to use it wherever you work. Tax contributions for the previous year are due by the deadline for filing taxes.
2. IRA contributions are tax deductible, but their limits are lower than those of other retirement savings plans. Traditional and Roth IRAs permit you to contribute $6,000 tax-deferred, plus $1,000 for age 50 and older. The same amount can be contributed to a Roth IRA after taxes. You can contribute to both a traditional IRA in the same year, but the combined total cannot exceed the IRS limit ($6,000/$7,000).
3. A tax deduction for an IRA contribution phases out after a certain income level (at $76,000 for singles and $125,000 for joint filers), and a Roth contribution is not allowed after taxable income for a married couple reaches $198,000 (or $125,000 for singles).
SIMPLE IRA
1. For midsize businesses with up to 100 employees, this is the best option.
2. SIMPLE IRAs are appealing due to the minimal paperwork required - just an initial document and an annual disclosure to employees.
3. It is very inexpensive to set up and maintain. Employer contributions and pretax employee salary deferrals are used to finance these plans.
4. The employer must either match up to 3% of a worker's pay or make a non-elective contribution of 2% of pay. The maximum contribution is $13,500, with a $3,000 catch-up if you are 50 or older.
5. Employees must have earned $5,000 from their employer during any of the two previous years, and they must expect to earn at least $5,000 this year.
SEP IRA
1. This is a great option for businesses with few or no employees.
2. Contributions are capped at $58,000 or 25% of employee compensation, whichever is less. Self-employed individuals can contribute up to $58,000 of their self-employment income up to 25% of their earnings.
3. This is an employer contribution plan, employee contributions are not allowed. Contributions must be made for everyone; only employees making less than $650 a year can be excluded from 2021.
4. Minimal paperwork and costs.
5. Contributions are due by Oct. 15 of the following year.
6. RMDs follow IRS guidelines, and loans are not allowed.
7. You can convert SEP IRAs to Roth IRAs.
Individual or Solo 401(k)
1. Suitable for a self-employed businessperson without employees other than a spouse
2. Employees may elect to defer up to $19,500 ($26,500 for those 50 and older) up to 100% of their compensation.
3. Furthermore, the self-employed person may make non-elective contributions of 25% of net income up to a maximum of $58,000 or $64,500 (including employee deferral amounts) if over 50.
4. Contributions from employers are due by April 15 or Oct. 15 if an extension was filed, but employee deferral elections must be submitted by Dec. 31.
5. Generally, you must open the plan by Dec. 31 of the current year. Depending on the plan, there may be an annual fee and a start-up fee.
6. An annual IRS Form 5500 must be filed once the plan exceeds $250,000. Roth 401(k)s are allowed, but RMDs apply: The Roth 401(k) version requires RMDs, unlike a regular Roth. You can contribute at any age.
7. Loans are allowed.
8. If the individual has a full-time job with an employer retirement plan and owns their own business, they may utilize the individual 401(K). Nevertheless, the maximum limit amounts are cumulative (i.e., the combined maximum for both plans is $19,500/$26,000). A combined contribution to the retirement plan and the 401(k) of an employer and an employee can't exceed $58,000/$64,000 respectively.
Defined-Benefit Plan
1. The best option for self-employed individuals with very solid cash flow and who want to contribute more than $60,000 per year to a retirement account.
2. Contributions are limited to a total of $294,500 when combined with a 401(k) profit sharing plan: This amount is equal to the IRS maximum of $230,000 for a defined benefit plan plus $64,500 for a 401(k).
3. These are typically the most complicated and expensive retirement plans to administer. CPAs and actuaries should be hired to set it up. Contributions are determined by a formula based on age and compensation history.
4. After the plan is established, the employer's contribution amount cannot be changed. Therefore, the employer is obligated to make the minimum contribution specified in the plan documents. Should the plan ever be frozen or terminated, it must be fully funded.
5. The plan is subject to excise taxes if the minimum contribution is not met. You can be charged excise taxes by the IRS if you have a poor year and cannot contribute as much as you had planned. The original plan's interest rate is established when the plan is set up.
6. Loans may be permitted.
7. Contributions to the plans are not capped by age, but RMDs are required.

Transition to an S-Corporation

One of the most powerful tax planning strategies consists on changing your business structure. You may want to consider changing your business structure from self-employed to an S corporation when you have profits of more than $60,000 per year.

Pass-through entities, like S corporations, have their income and losses passed through to their owners, who are taxed individually. The owners of S corporations do not have to pay self-employment tax on their share of profits (dividends). Profits are taxed based on the rate they pay as an individual. While you pay your employee's half of Social Security and Medicare, the corporation pays the other half and is considered a business expense. You save money because you won't have to pay self employment tax on the difference between your salary and the profit of the corporation.

Changing from self-employed to a S corporation is not an easy task. There are many more expenses associated with maintaining the corporation as well as additional requirements imposed by the IRS that do not apply to self-employed individuals. Among these requirements are payment of yourself as an employee and the timely filing of payroll reports and the payment of payroll taxes.

You should seek guidance from a tax professional in the evaluation of this tax planning strategy. Using their services, you can calculate the financial benefit of changing the structure, as well as shed light on the additional compliance requirements and costs associated with the change.

We provide you with a detailed tax plan strategy

We believe self-employed people need to be aware of some of the main tax planning strategies that exist. Tax deductions and strategies can reduce your income tax bill if you consider this information. For more information about how much money you could be saving if you tried any of the strategies discussed in this article, or any other strategy not covered in this article, we would be happy to work with you.

We provide tax plan analysis and reports that outline what strategies to implement and what savings you can expect to realize through the implementation of these strategies. We have saved our self-employed clients thousands of dollars, and we can do the same for you. Please contact us or book an appointment now.

The Essential Tax Planning Guide for the Self-Employed

Self-Employment

Home Office

Health Insurance Premiums

Vehicle Use

Business Insurance

Maximize Retirement Contributions

Traditional or Roth IRA Plans.

SIMPLE IRA

SEP IRA

Individual or Solo 401(k)

Defined-Benefit Plan

Transition to an S-Corporation

We provide you with a detailed tax plan strategy