Whether you run a local mom-and-pop microbusiness, want to become a real estate agent, or do freelance work on the side of your day job, there are many legitimate, money-saving tax benefits you shouldn't miss.
Don’t miss several of the best ways to reduce taxes as you start or grow a part- or full-time business.
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You're in great company if you have a side gig or small business or want to earn additional income as a part- or full-time entrepreneur. According to the Small Business Administration, there are more than 33 million small businesses in the U.S., defined as having fewer than 500 employees.
Interestingly, 81% or about 26 million of small businesses are nonemployer, meaning they don’t have paid employees. They’re typically small, such as real estate agents, freelancers, and independent contractors.
Whether you run a local mom-and-pop microbusiness, want to become a real estate agent, or do freelance work on the side of your day job, there are many legitimate, money-saving tax benefits you shouldn't miss. This show will review several of the best ways to reduce taxes when you have a little or a lot of business income.
Hey, friends, and welcome back to the Money Girl podcast—I appreciate you downloading the show! I'm Laura Adams, an award-winning author who's been bringing you personal finance tips every week since 2008, with over 40 million downloads.
I'm also a keynote speaker and work with select brands doing on-camera and writing work as a spokesperson and consumer advocate. Please reach out if you want to collaborate for a speaking event or PR campaign!
As always, you can reach me using my contact page at LauraDAdams.com. That's also where you can learn more about my work, award-winning personal finance books, and money courses. You can also leave me a message or a money question by calling 302-364-0308.
RELATED: 6 Tips to Find Affordable Health Insurance When You Become Self-Employed
There are many ways having a part- or full-time business saves money. Let’s review four essential tips for reducing taxes when you’re self-employed.
1. Claim the home office tax deduction.
If you use part of a home (that you rent or own) for business purposes, you probably qualify for the home office tax deduction, a valuable tax break. Note that employees working from home or remotely don't qualify for this benefit—it's only available when you work for yourself (even if you also have an employer).
To qualify for the home office deduction, you must have a specific part of your home that you use consistently for business, such as a guest room or nook. And your home must be the primary place where you conduct business—but it doesn't have to be the only place you work.
The types of home office expenses you can claim fall into two main categories: direct and indirect.
Direct expenses are for your home office only, such as purchasing a desk or installing carpet in that space or room, and are 100% deductible.
Indirect expenses for your home office include a portion of your home's costs, such as rent, mortgage interest, property taxes, insurance, maintenance, cleaning, utilities, and garbage disposal. Did you catch that? Claiming the home office deduction makes some of your everyday home-related expenses deductible, which is fantastic!
Your indirect home office expenses are partially deductible based on the size of your office—but it depends on how you calculate the deduction. Also, note that expenses unrelated to your home office, such as remodeling other parts of your home, are never deductible.
The IRS allows you to choose one of the following home office calculation methods for any year:
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.
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, Profit or Loss From Business.
2. Deduct your business expenses.
There are many tax deductions and credits you can claim, no matter the size of your business. The IRS says an expense must be ordinary and necessary for your trade or business to be tax-deductible. Some common business deductions for entrepreneurs and side-gigs include:
Note that if you have personal and business costs, such as a vacation combined with an industry conference, you can deduct the portion used for business. That isn't a complete list, so refer to Publication 535, Business Expenses, for more deductions that may apply to your business.
3. Claim business vehicle use.
If you're self-employed and own or lease a personal vehicle you drive for your business, you can deduct expenses based on mileage. That means keeping detailed records to allocate business versus personal miles driven. However, if your vehicle is used exclusively for business, you can deduct all its costs.
The IRS allows you to choose one of the following vehicle deduction calculation methods:
You can track mileage with a paper log, but there are handy apps, like MileIQ, that automatically record vehicle movement and prompt you to allocate each trip as personal or business.
For more information on vehicle deductions, check out Publication 463, Travel, Entertainment, Gift, and Car Expenses.
4. Make retirement plan contributions.
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. Retirement accounts help you accumulate a nest egg and allow you to keep more of your hard-earned money by cutting taxes.
There are two main types of retirement accounts: traditional and Roth. With traditional accounts, you invest pre-tax money and avoid taxes on contributions and account growth until funds are withdrawn.
With Roth accounts, you pay taxes upfront but can make tax-free withdrawals in retirement. You avoid tax on decades of account earnings, which could add up to massive savings.
Remember that with most retirement plans, taking early withdrawals before age 59½ typically means paying tax plus an additional 10% penalty. So, it's important not to contribute money you might need for everyday expenses.
Here are a couple of popular retirement accounts with high contribution limits you can use when you work for yourself:
A SEP-IRA, or Simplified Employee Pension, is a traditional plan for anyone self-employed with or without employees. A Roth option is a new provision in the SECURE Act but may not roll out to most plans until 2024.
I use a SEP because it's easy to set up by filing Form 5305-SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, and inexpensive to administer.
With a SEP-IRA, contributions only come from the employer; employees can't contribute their own money. So, as the business owner, you choose the amount to contribute each year. The contributions you make are deductible from your business' taxable income.
For 2023, you can make SEP-IRA contributions up to 25% of compensation or your net earnings for a maximum of $66,000. But if you have a bad year with little profit, you can choose not to make SEP-IRA contributions.
A solo 401(k) is a traditional or Roth plan for anyone self-employed with no full-time employees other than a spouse. You can contribute as both the employer and employee in your business, allowing you to contribute more than other plans.
For 2023, on the solo 401(k) employee side, you can contribute as much as 100% of your salary up to $22,500 or $30,000 if you're over 50. Remember that traditional, pre-tax contributions reduce your personal income taxes for the year, but Roth contributions don't give you an upfront tax benefit.
Plus, as an employer with a solo 401(k), you can contribute up to 25% of compensation if your total contributions don't exceed $66,000 or $73,500 if you're over 50. Those employer-paid pre-tax contributions are tax-deductible for your business. However, if you elect a solo Roth 401(k), your contributions don't reduce your personal or business's taxable income.
You can set up a solo 401(k) with many financial institutions, such as banks and brokerage firms, after opening an account and completing a plan adoption agreement. Once your solo 401(k) assets exceed $250,000, you must file Form 5500-EZ, Annual Return of A One-Participant Retirement Plan, annually.
In my most recent book, Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers, I cover more about retirement plans, choosing a business entity, taxes, building a self-employed benefits package, paying employees and contractors, cutting taxes, boosting productivity, and many other essential topics for business owners.
If you need help setting up a retirement plan or maximizing your business' tax benefits, contact a qualified tax accountant. I've covered only a few of the top tax benefits for business owners here, but there are many more. Paying for professional help as you start or grow a business can really pay off.
That's all for now. I'll talk to you next week. Until then, here's to living a richer life.