If you already have a business or you're thinking about becoming self-employed, don't miss these legitimate ways to reduce expenses, cut taxes, and save more.
If you already have a business or you’re thinking about becoming a self-employed entrepreneur, you’re in great company. According to the Small Business Administration, there are more than 30 million small businesses in the U.S.
By official measures, a small business is a venture that employs fewer than 500 workers. And surprisingly, they make up 99% of all businesses in the U.S. There are only about 20,000 large businesses, which have 500 or more workers.
Interestingly, 85% or 26 million small businesses have no employees. The Census Bureau calls this category “non-employer” businesses, but the nickname that’s stuck for these one-person ventures is “solopreneur.”
As consumers, we rely on these millions of solopreneurs and small businesses for a vast array of goods and services. Additionally, running your own full- or part-time venture comes with many financial advantages.
In this post, I’ll review seven ways that having a small business saves you money. You’ll learn legitimate, money-saving tax deductions that reduce both business and personal expenses. I’ll also cover tax changes that affect small businesses due to the Tax Cuts and Jobs Act of 2017.
7 Tax Deductions for Small Business Owners
- Business expenses.
- Home office expenses.
- Vehicle expenses.
- Insurance expenses.
- Travel and meal expenses.
- Retirement plan contributions.
- Qualified business income deduction.
Here’s more detail about each of these money-saving tax deductions for business owners and solopreneurs.
1. Business expenses
There are a variety of deductions you can claim no matter if you’re a solopreneur with no employees, a part-time freelancer, or the owner of a large corporation. Business tax deductions were created to help entrepreneurs manage the costs of running a profitable company.
To be deductible, the IRS says an expense must be both ordinary and necessary for your trade or business. Some common deductions for small businesses and solopreneurs include:
- Employee salaries and benefits (except when you employ yourself)
- Labor paid to independent contractors or freelancers (when payments exceed $600 per year, you’re required to issue Form 1099-MISC)
- Professional fees, such as legal and accounting work
- Rent for the use of property, office space, or equipment
- Interest on funds borrowed for real estate and business operations (there are limitations when you have high annual revenue)
- Taxes paid to federal, state, local, and foreign authorities
- Equipment, such as computers, printers, and phones
- Office supplies, such as postage, paper, and filing cabinets
- Marketing costs
- Continuing education
This isn’t a complete list of possible deductions you may have, so be sure to check out Publication 535, Business Expenses for more information.
In general, you can’t deduct your personal or living expenses. However, if you have costs that are both personal and business, such as a vacation combined with an industry conference in Hawaii, you can deduct a portion used for business.
2. Home office expenses
If you use part of your home for business, you may be allowed to deduct a variety of expenses by claiming the home office tax deduction. If you qualify, this is a valuable tax break that you shouldn’t miss.
Before the Tax Cuts and Jobs Act, the home office deduction was available to both employees and the self-employed. But the law eliminated the deduction for employees because it removed miscellaneous deductions from Schedule A, Itemized Deductions. That’s where workers would include home office deductions, up to a limit. So, if you’re an employee working from home, you’re no longer allowed to claim a home office deduction starting with the 2018 tax year.
If you’re self-employed, you can claim a home office deduction no matter if your venture is full-time, part-time, or if you’re a homeowner or renter.
But those who are self-employed can still claim the home office tax deduction. If you freelance, are a contractor, or run a small business, you claim the deduction using Schedule C, Profit or Loss From Business, which is the same method as before tax reform.
If you’re self-employed, you can claim a home office deduction no matter if your venture is full-time, part-time, or if you’re a homeowner or renter. You don’t need to have a business license or a tax ID number to claim valid deductions.
Here are the two basic requirements you and your home office must meet to be eligible for the deduction:
- Exclusive use – requires you to use a specific part of your home for your business consistently.
- Principal place of business – requires you to use your home as your primary location where you conduct your business.
As I mentioned, your business could be part-time. If you have a full-time job at another company and work on your business from home in the evenings, you’re still qualified for the deduction, if you meet these requirements.
The types of home office expenses you can claim fall into two main categories, which are direct and indirect expenses. Direct expenses are for your home office only. For instance, if you create an office in your spare bedroom by painting the room, installing carpet, and purchasing a desk, those expenses are 100% deductible.
But the best part about claiming the home office deduction is that it turns some of your everyday costs, known as indirect expenses, into business write-offs.
But the best part about claiming the home office deduction is that it turns some of your everyday costs, known as indirect expenses, into business write-offs. These are expenses that you’d have even if you didn’t have a home office, such as rent, mortgage interest payments, property taxes, insurance, maintenance, cleaning, utilities, and garbage disposal.
To clarify, expenses that are unrelated to your home office, such as adding a pool or remodeling other parts of your home, are never deductible. And no matter where you work when you’re self-employed, your business expenses, such as those covered in the previous tip, are always fully deductible.
Your indirect home office expenses are partially deductible based on the size of your office—but it depends on how you calculate the deduction. The IRS allows you to choose one of the following calculation methods:
- Standard home office deduction - requires you to determine the percentage of your home you use for business. You divide the square footage of your office area by the square footage of your entire home. That percentage gets applied to your indirect expenses, such as utilities, insurance, and maintenance. For example, if your office is 10% of your home, and you have a $100 power bill, $10 would be a deductible business expense and $90 would be a personal expense.
- Simplified home office deduction - gives you $5 per square foot of your office area, up to a maximum of 300 square feet. So, that caps your deduction at $1,500 (300 square feet x $5) per year.
You can choose the method that gives you the biggest tax break for any year. If your home office is large, you’ll come out ahead using the standard method. You figure your total expenses using Form 8829, Expenses for Business Use of Your Home and file it with Schedule C. If you have a smaller home office or just prefer not to do any record-keeping, use the simplified method and include it on Schedule C.
And if you’re not sure which method saves you the most taxes, calculate both or consult with a qualified tax accountant. Getting professional advice can help you to make the most of your potential home office and business deductions each year.
3. Vehicle expenses
If you’re self-employed and own or lease a personal vehicle that you also drive for your business, you can deduct expenses based on mileage. You must keep detailed records of your trips so you can allocate business versus personal miles driven. However, if your vehicle is used solely for business, you can deduct all its costs.
The IRS allows you to choose one of the following calculation methods for the business vehicle deduction:
- Actual expenses – requires you to track your auto expenses, such as gas, tires, maintenance, insurance, lease payments, loan interest, depreciation, registration fees, taxes, parking, and tolls. You can deduct a portion of the expenses based on your percentage of business use. For instance, if 10% of your total annual miles driven are for business in a given year, you could deduct 10% of your vehicle expenses.
- Standard mileage rate – requires you to use a set mileage cost per mile, which typically changes every year. For 2019, the rate for business use is 58 cents per mile. For instance, if you drove 1,000 miles annually for business purposes, your vehicle deduction would be $580 (1,000 x $0.58). When you use this rate, you can’t also deduct your actual vehicle expenses. However, if you have an auto loan, you can still deduct the portion of interest that represents your business use of the vehicle, plus any parking fees and tolls, in addition to the standard mileage rate.
In general, the more expensive your vehicle is to operate, the better off you’ll be using the actual cost method. For more economical vehicles, you may come out ahead using the standard mileage deduction.
You can track your vehicle business mileage with a simple method, such as a paper log or a note on your phone. However, there are some handy apps, such as MileIQ, which automatically records your vehicle movement and prompts you to allocate each trip as personal or business. That can make record-keeping for the vehicle deduction much easier!
Check out Publication 463, Travel, Entertainment, Gift, and Car Expenses for more information or consult with a qualified tax accountant.
4. Insurance expenses
Having the right kinds of insurance can be critical for surviving unexpected financial hardships. The costs of various insurances are deductible when you’re self-employed. These might include policies for business liability, interruption, errors and omissions, malpractice, property, cyber theft, and vehicles.
However, if you purchase health insurance for yourself and your dependents, it’s not an allowable business expense. Instead, you can deduct premiums on your personal tax return (Schedule 1, Form 1040) provided you’re not eligible to participate in a health plan through your or your spouse’s employer.
5. Travel and meal expenses
And speaking of travel, going out of town on business for more than one day is a deductible expense when you’re self-employed. You can write off the full cost of airfare, ground transportation, and lodging. However, meals are handled differently and are only deductible up to 50%.
Tax reform eliminated the deduction for business entertainment. However, you can still claim half the cost of meals if you purchase food or beverages during a recreational event. Just like with other types of deductions, it’s critical to keep good records and receipts.
Going out of town on business for more than one day is a deductible expense when you’re self-employed.
As I previously mentioned, if you extend a business trip into a personal holiday, you can deduct a portion of expenses based on the percentage of time you spend on the business. That’s an easy way to save money when work takes you to a destination where you want to spend extra time.
6. Retirement plan contributions
If you think being self-employed is a disadvantage when it comes to saving for retirement, it’s time to change your thinking. There are some fantastic retirement plans designed just for small business owners and solopreneurs.
Just like more familiar workplace plans, such as a 401(k) or 403(b), retirement accounts for the self-employed give you (or your employees) money-saving tax benefits. Not only do retirement accounts help you accumulate a nest egg, they also allow you to keep more of your hard-earned money by reducing your taxes.
Not only do retirement accounts help you accumulate a nest egg, they also allow you to keep more of your hard-earned money by reducing your taxes.
When you invest pre-tax money in a traditional retirement account, you avoid paying taxes on contributions and growth in the account until funds are withdrawn. You may also have the option to choose a Roth account, which does require you to pay taxes upfront, but allows tax-free withdrawals later on. Having a Roth means you avoid paying tax on decades of earnings in the account, which could add up to massive savings.
Remember that with most retirement plans, taking withdrawals before age 59½ typically means you’re subject to income tax plus an additional 10% early withdrawal penalty. So, it’s important not to contribute money that you might need for everyday living expenses. There are a variety of retirement accounts you can use when you work for yourself.
A SEP-IRA, or Simplified Employee Pension, is a traditional IRA for anyone self-employed without or with employees. You could be a sole proprietor, partnership, or a corporation. I use this plan because it’s easy and inexpensive to administer.
With a SEP-IRA, contributions can only come from an employer. If you have employees, they can never contribute their own money. So, as the business owner, you choose the amount to contribute each year.
For 2019, you can make SEP-IRA contributions up to 25% of compensation or your net earnings, for a maximum of $56,000. You can also max out other accounts, including a traditional or Roth IRA and a retirement plan with another employer, such as a 401k or 403b. But if you have a bad year with little profit, you can choose not to make any contributions to your SEP-IRA.
A Solo 401(k) is a traditional 401(k) or a Roth 401(k) for anyone self-employed with no employees, other than a spouse. As both the employer and employee in your business, you can make both kinds of contributions to a one-participant 401k account. This option allows you to contribute more than with any other type of retirement account.
For 2019, on the employee side of a solo 401k, you can contribute as much as 100% of your salary up to $19,000, or $25,000 if you’re over age 50. Plus, as the employer, you can contribute up to 25% of compensation, if your total contributions don’t exceed $56,000, or $62,000 if you’re over 50.
An IRA or Individual Retirement Arrangement is for anyone with earned income. Even non-working spouses who file taxes jointly with a working spouse qualify for a spousal IRA. However, there are income limits to qualify, so high earners may become ineligible for a Roth IRA. For 2019, you can contribute a total of $6,000, or $7,000 if you’re over age 50, to one or both types of IRAs.
If you need help setting up a retirement plan or aren’t sure how to use multiple retirement plans properly, be sure to contact a qualified tax accountant. Paying a professional to help you maximize tax benefits for your business and retirement accounts will pay off.
Free Resource: Retirement Account Comparison Chart (PDF download) is a handy, one-page resource to understand different types of retirement accounts.
7. Qualified business income deduction
Another significant change for small businesses that the Tax Cuts and Jobs Act created is the qualified business income (QBI) deduction. It allows owners of pass-through businesses—that is, businesses not subject to corporate income tax, including sole proprietorships, partnerships, and S corporations—to deduct 20% of their income.
To qualify for 2019, you must have taxable income below $157,500 as an individual, or $315,000 if you file taxes jointly. For all income within these limits, 20% is not taxed. However, some professionals, such as doctors and attorneys, are subject to higher income thresholds they must meet before the QBI deduction kicks in.
Tax reform changed the way tax is calculated for most taxpayers. So, even if you’re not self-employed, be sure to review your federal and state tax withholding. That will help you avoid a surprise tax bill and a potential penalty.
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