If you’re self-employed and pay for your own health insurance and/or work-related expenses, be sure to maximize your deductions. Here are some key points:
Regarding Deductions Related to Business Expenses:
- Itemize deductions rather than take the standard deduction.
Self-employed individuals are allowed by the IRS to deduct many expenses that regular employees cannot claim. For example, if you are self-employed, you can deduct not only your cell phone bill, but the entire cost of your cell phone (and landline). If you are an employee, you can’t.
If you are self-employed, you can also deduct many of your home office expenses – mortgage interest, real estate taxes, maintenance and repairs, utilities and housekeeping supplies — as well as most of your auto expenses. But if you are an employee, these expenses must be added back to your income before deductions are calculated.
- As a self-employed individual, you have the option of deducting your “business expenses” on your tax return. However, there are some limitations. Your business expenses must be “ordinary and necessary.” What is considered ordinary varies depending on what type of business you are in.
Business expenses that are not considered “ordinary” must be deducted as itemized deductions on Schedule A of Form 1040.
- If you freelance, or run a side business like consulting, you can deduct your travel expenses. This includes not just your airline tickets but also your miles driven and parking costs. What’s more, the deduction isn’t limited to business; if you take a vacation that includes business, that’s fine. It doesn’t matter why you went there; the destination is irrelevant. If you visit an aunt in Florida while doing consulting work at Disney World, you can deduct your mileage to and from her place. You can also deduct meals while driving or eating while stopped for gas — though remember you can only deduct 50% of meals away from home, so keep track if it’s more than half your drive time.
A related deduction is unreimbursed employee expenses. This is mostly used by self-employed professionals who have to work at their home offices, but it’s also available for anyone who has to use their own car for work trips (for example, if you’re a real estate agent). The IRS allows you to deduct mileage for using your car for both personal and business trips (you just need to keep records), and other expenses like tolls, parking charges, and certain equipment rental fees.
Regarding Deductions Related to Healthcare and Retirement:
- Your tax bracket is not your tax rate. Your income is not your gross. income. Your income is what you take home. Your gross income is what you are paid, before any money is taken out for deductions or payroll taxes.
For most people, the most important of these deductions are for contributions to a retirement fund and for health insurance premiums. Both of these deductions come in the form of being able to write off part of your annual contribution up front in the year you make it, instead of having to wait until you file your return.
This is not true for people who are self-employed, who have to pay their own Social Security tax out of pocket. The up-front deduction doesn’t apply to them. They can’t deduct money they never got in the first place, because contributions are made on a pre-tax basis.
- If you are self-employed, you can deduct the cost of health insurance for yourself, your spouse and your dependents if you are paying the premiums with after-tax dollars. If you are not self-employed, this deduction is not available to you — but you can buy your health insurance through your employer, which will be able to subtract the cost from your taxable income.
The tradeoff here is that if you are getting health insurance through your employer, you will pay lower premiums, but you will also pay payroll tax on your share of the premium. Plus, if you are getting a relatively expensive plan, the extra payroll tax might end up being more than the tax benefit from deducting the premiums. On the other hand, if anyone in your family has a history of health problems or is likely to have significant medical expenses at some point in his or her life (for example, because he or she has diabetes), buying an individual policy might well make sense.
- Those who are self-employed face some special tax issues, and one of the most important is what to do with health insurance. The first thing to realize about health insurance is that it’s mostly about taxes.
Wages are taxed, and so are most kinds of income. Health insurance premiums are not, however, and neither are contributions to an HSA. Your employer pays half of your health insurance premium with pre-tax dollars, but you pay for the other half yourself with after-tax dollars. The pre-tax/after-tax difference is a huge incentive to buy more health insurance than you need.
The reason is that the IRS lets you deduct the amount of your health insurance premiums from your taxable income. If your employer gave you an extra $10,000 in cash, it would be taxed at ordinary income rates of up to 35%, plus you would have to pay payroll taxes on top of that. But if your employer put $10,000 worth of health insurance premiums into your flexible spending account, it would be taxable income but would not be subject to payroll taxes. An extra $10,000 worth of health insurance premiums is worth $5,000 more to you than the same amount in cash.
- Make sure you have the right insurance coverage. The best option is a traditional individual policy. If you qualify for a government subsidy to buy insurance on the national exchange, that may be cheaper than buying a traditional policy. But if you don’t qualify for a subsidy, the deductibles and copays may be so high as to make the policy worthless as a deduction.
If you aren’t eligible for a subsidy, look for an individual policy with a relatively high deductible and low premiums and copays. A high deductible means that most of your medical bills will come out of your pocket and thus be deductible. A low premium is less important–you can deduct premiums above the standard deduction anyway–but low co-pays are important because they will let you make bigger tax-free withdrawals from Health Savings Accounts (HSAs).
- If you are self-employed, you can deduct all your health care expenses, including premiums paid for yourself, spouses, children under age 27, and even grandchildren under age 27 on your tax return.
Emil is a contributor at Accountant Log. We are committed to providing well-researched, accurate, and valuable content to our readers.
