Tax Deductions for the Self-Employed

Starting your own business, whether on the side or full-time, can be a great way to turn costs that you would incur anyway into legitimate, tax-deductible business expenses. If you conduct a business activity on a regular basis with the intent of making a profit, the income is generally subject to self-employment tax. The tax rate is 15.3% on the first $102,000 of net income from self-employment and 2.9% on the remainder.

Common Tax-Deductible Expenses

Self-Employment Tax Deduction

First, you get to deduct half of your self-employment taxes from your net income. Second, you only incur self-employment tax on your net business income, or what's left over after you subtract your business expenses. Finally, you only pay self-employment tax on 92.35% of your net business income (in 2009).

Home Office

Any workspace that you use regularly and exclusively for your business, regardless of whether you rent or own, can be deducted as a home office expense. The expenses you can deduct for your home office include the business percentage of rent or mortgage, property taxes, utilities, home owners insurance and home maintenance that you pay during the year.

Health Insurance Premiums

If you are self-employed, pay for your own health insurance premiums, and were not eligible to participate in a plan through your spouse's employer, you can deduct all of your health, dental and long-term care insurance premiums. What's more, you can also deduct premiums that you paid to provide coverage for your spouse and dependents.

Meals and Entertainment

To deduct meals and entertainment you must conduct business with the person you are entertaining during the meal/event or immediately before or after it. These expenses are only 50% deductible, not 100%. Examples of deductible expenses in this category include tickets to a sporting event, the cost of a meal (with beverages, tax and tip), or the cost of a game of golf.

Internet and Phone

If you have only one phone, you shouldn't deduct its basic monthly charge, which you would likely incur whether you worked from home or not. You should only deduct costs that specifically relate to your business. If you have a second phone line that you use exclusively for business, however, you can deduct 100% of that cost. By the same token, you would only deduct your monthly internet expenses in proportion to how much of your time online is related to business.

Car

When you use your car for local business trips, your vehicle expenses for those trips are tax deductible. You can either deduct the standard mileage rate (determined annually by the IRS) or deduct your actual expenses. To use the actual expense method, you must calculate the percentage of driving you did for business over the course of the year as well as the total cost of operating your car during the year, including gas, oil changes, repairs and car insurance

Travel

Your trip should have a specific business purpose planned before you leave home, and you must actually engage in some business activity - such as finding new customers, meeting with clients, or learning new skills directly related to your business. Deductible travel expenses include the cost of transportation to and from your destination, the cost of transportation at your destination, lodging and meals. 100% of your travel expenses for business are deductible, except for meals and entertainment, which are limited to 50%. If your trip does not involve an overnight stay, you can still deduct the cost of transportation, but you cannot deduct the cost of meals as a travel expense. 

Self-Employed Retirement Plans

Self-employed retirement plans are particularly valuable for reducing your tax bill now and racking up tax-deferred savings for later. Those who don't make quite as much can contribute to both a self-employed retirement plan and an IRA (as long as you are within the IRA's income phase-out limits).

Conclusion

Most self employed deductions are a bit more complicated than can be explained in this brief overview, but this is a good introduction to the basics. Remember, any time you're not sure whether an expense is a legitimate business expense, ask yourself, "Is this an ordinary and necessary expense in my line of work?" This is the same question the IRS will ask when examining your expenses if you get audited. If the answer is no, don't take the deduction. Because the rules are always changing financial planners and CPAs should always be consulted when filing a business return.