Self-Employed Deductions for USA Federal Income Taxes
Anyone that is self-employed running a side hustle or small business will have to report their business revenue to the government. This additional income will have federal income taxes due, which can surprise people working for themselves for the first time.
If you don’t know any better, you may actually claim your full business income and pay taxes on it. However, almost all businesses can reduce their tax liability by claiming business deductions. I’ve been partially or fully self-employed for more than 26 years now, so I have a lot of USA income tax knowledge I can share with you that can save you a ton of money.
Hire a Tax Professional
The information contained in this article is for educational purposes only. I highly recommend that you hire a tax professional to help you with filing your federal income tax return for your business to ensure that it’s done properly. I’ll mostly be teaching you about deductions in this guide. Gather a list of these deductions and bring that list to your person you hire to prepare and file your taxes.
With that said, I do have a lot of experience with self-employment taxes. Every tax return of mine for the last 26 years or more has had a Schedule C filed to include business revenue and deductions, so I personally use the knowledge from this guide every single year.
The tax pro that files my taxes each year is actually my dad. This is ultimately where all of my self-employment tax knowledge originates. My dad has been a CPA his entire adult career. He’ll likely be retiring in the next few years, but my brother is also a CPA and currently runs the business with him. For more than 10 years now, he has run his own tax and accounting business that has two locations in South Carolina: Stevenson Tax & Accounting.
While they mostly work with local clients in Upstate South Carolina, they also have clients worldwide, so you can contact them and hire them to do your taxes if you want someone with a lot of experience with this type of taxes. I live in Florida about 800 miles from their offices, and they still do my taxes. Tell them Ryan Stevenson sent you!
Self-Employed Sole Proprietorship
You can actually file taxes for a business in numerous different ways. If you incorporate your business, you’ll have to keep separate finances for you and your business and file separate tax returns. I’ve always kept things simple with my businesses since I don’t usually utilize employees. I legally operate my businesses under my name as a sole proprietorship. You should have a discussion with your accountant to figure out what will work best for you and your business though.
As a sole proprietorship, my personal accounts and business accounts are all legally owned by me. The business revenue is counted as my income and taxed as such. I could also be held personally liable for business losses and/or damages, but I don’t deal in businesses where this is likely to happen. Most side hustles are run as a sole proprietorship too. Basically, if you start a business and don’t register it as a legal business entity then it will be a sole proprietorship unless you have a business partner.
With that said, the information that I provide in this guide is specifically intended for sole proprietorships. However, any legal business entity can still take advantage of business deductions – the rules on exactly what is allowed can simply change depending on the legal status of your business and how your taxes will be filed. For any legal business entities, you should definitely be working with a tax professional.
While there are some more complex rules surrounding what you’re allowed to deduct as a business expense on your tax return, I’m going to try to simplify it as much as possible for you here. As a result, make sure you create a detailed list of your business deductions to provide to your accountant. They will be able to scrutinize your list to ensure that you’re not trying to take a deduction for an expense that isn’t allowed.
In general, most of the money that you spend to start, run and even expand your business can potentially be deducted on your taxes. This is important because it affects how much you’ll have to pay in federal taxes each year. If you have $100k in business revenue and $50k in expenses, you’ll only have to pay taxes on the profits of $50k instead of the full $100k. Some businesses can have low profit margins, so you really don’t want to get stuck paying a tax bill for your full business revenue.
Inventory, website hosting, domain name costs, payment processing fees, shipping supplies, shipping costs, legal fees, employee wages, and more are potential business deductions. Think about the product or service that you sell. What do you have to spend money on to be able to offer and fulfill those sales? Any of these expenses could be valid business deductions, so you want to make sure you track everything. Again, bring this list to your CPA that will prepare your taxes to get them to verify that they’re all allowed expenses.
Some types of business expenses have special rules that need to be followed to deduct them. In general, if you buy something for your business that you’ll use for more than one year, you’ll need to break up that deduction over the lifespan of the asset. This is called depreciation in the tax world.
Let’s say you’re running an online business, so you buy a new computer for $2,000 to use for work. You estimate that the computer will last for 5 years before you buy another one to replace it. On your taxes, the $2k isn’t deducted all at once – it’s split up over the 5-year lifespan. This depreciating asset then gives you a $400 deduction each year for 5 years total. After 5 years it is considered fully depreciated and no longer provides a deduction after that.
In some cases, this can really benefit your overall tax liability. Early in a business you may not have a lot of revenue but need to spend money to grow. Once your taxable income is reduced below a certain level, additional deductions won’t really help you much. However, if those deductions are depreciating assets then you can spread them out over numerous years. As a result, when your income level goes up after a couple of years, you’ll still have reduced tax liability from the depreciation deductions left over from years ago.
Another special type of deduction involves business meals. If you travel for a convention or simply have to drive for hours to collect inventory, you’ll likely have to eat at some point. Maybe your business requires taking potential clients out to dinner to try to land a deal. Business meals can qualify as a deduction.
One of the main things to remember is that you only get 50% of the cost of your meals as a deduction. There’s another option that gives you a set deduction for each day that meals are needed, but this is honestly outdated and nowhere close to the price of food these days so I’ve always done the 50% deduction.
Keep in mind, this is not an open invitation to deduct the cost of every meal you eat. This is just for meals that are required while you’re on business, often during travel. Trying to abuse this deduction can land you an audit from the IRS.
Home Office Deduction
When you work at home and are self-employed, you can take a home office deduction. Figure out the total heated square footage of your home and how much space you use for your home office. If you have a 2000 sq ft house and use 200 sq ft as a home office, you’ll get to deduct 10% of many of your home’s expenses.
Rent or mortgage payments will be the biggest contributor to this deduction, but you can also deduct the cost of utilities as well. If you happen to have some utilities, like an internet connection, that are exclusively used for your business, you can completely deduct those costs. The rest of the house expenses go towards this home office deduction.
You’ll want to bring your tax professional all of the relevant numbers that are used for this calculation and not just the final result. They’ll need the total and office square footage and the total house expenses. If you’re unsure about whether a particular house expense qualifies, just list the amount separately to get the advice of your accountant.
Vehicle Work Mileage
When you have to use your personal vehicle for business purposes, you’re spending money and causing wear and tear to the vehicle. You do not get to deduct the cost of gas or car maintenance, but you can take a deduction for the number of miles driven for your business.
In 2022, this mileage deduction is 58.5 cents per mile. Again, this is only driving for your business and not personal driving. If you have to drive to collect inventory or deliver boxes to the post office to ship to customers, those are valid mileage deductions.
To be able to take this deduction, you need to keep a log book of your miles. I like to keep a small notepad in my van that I use for inventory and shipping runs. Start tracking mileage at the start of the trip, and then record it at the end. You’ll also want to note the date and the purpose for the trip in your log. In more recent years, I started using QuickBooks. They offer a feature in their mobile app that will track all of your driving for you. You can then go through the driving log and select the business trips to use for deductions.
Quarterly Estimated Tax Payments
When you reach a point where your business is making decent profits and generating a federal income tax bill each year, you’ll need to begin making quarterly estimated tax payments to the IRS. When you file your first tax return that generates a federal tax debt, your accountant can print out payment vouchers for you for the coming year.
It’s also worth noting that these quarterly tax payments aren’t actually timed perfectly. Quarter 2 is only two months long, and quarter 4 is 4 months long.
End of “Quarter” Dates:
- Jan 1 – March 31 : Due Apr 15
- Apr 1 – May 31 : Due June 15
- June 1 – Aug 31 : Due Sept 15
- Sept 1 – Dec 31 : Due Jan 15
On those dates each year, you will have to make an estimated tax payment to the IRS. If you do not make these payments, you’ll get charged additional late fee penalties and interest. This simply means that if you avoid this responsibility each year, it will cost you more money to just pay taxes once a year.