Common Self-Employment Tax Deductions: A Comprehensive Guide

Self-employment has its perks—the primary ones being the freedom of being your own boss and the potential of earning more. However, it also comes with the responsibility of handling your finances and paying your tax liabilities, like the self-employment tax. While the tax may seem like a burden, there is good news: you have a comprehensive list of tax deductions that can reduce your tax liability as a self-employed person. From business expenses to home office deductions, retirement contributions, to health insurance premiums, there is a range of self-employment tax deductions. 

So, if you're a self-employed person, small business owner, freelancer, or gig worker, this blog will guide you through the most common self-employment tax deductions and how to utilize them. You will see how they can empower you to optimize your tax strategy and minimize the amount you owe to the IRS.

What is Self-Employment Tax?

Self-employment taxes refer to the taxes that self-employed people or small business owners pay to the government. Consider it the counterpart of the Federal Insurance Contributions Act (FICA) tax that employers pay. These include

• Social Security Tax
• Medicare Tax

Self-employment tax is reported via IRS form 1040 Schedule SE.

Note: Self-employed individuals who earn less than $400/year are exempt from this tax.

Self-Employment Tax Rate?

Self-employed people pay FICA taxes in the form of self-employment tax at a rate of 15.3%. Out of 15.3%, 12.4% accounts for the employer and employee portions (6.2% each) of FICA taxes, while the remaining 2.9% is for Medicare. Those earning over $200,000 must pay an additional 0.9% for Medicare.
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Let us understand Social Security and Medicare in more detail.

Social Security Tax

Social Security Tax is a payroll tax levied on employers and employees. The tax is used to fund the social security program that provides retirement, disability, and other perks to eligible people. You withhold the social security tax from employees' pay and remit the amount to the IRS. 

Self-employed individuals must pay both the employee and employer portions of these taxes through the self-employment tax. 

Medicare Tax

Medicare is another employer-employee tax where you withhold a certain amount of an employee's wage and then match an equivalent amount to contribute to FICA taxes.

The tax funds Medicare health insurance, a federal health program that benefits eligible people below 65 and all above 65.

The Relationship Between Sole Proprietorship and Self-Employment

While the terms are similar, there are subtle differences between self-employment and sole proprietorship. Let's understand the terms individually and then move on to how they're related.

Sole Proprietorship: It is a business structure where a single person owns and operates an unincorporated business. There is no legal distinction between the business and its owner, who is personally responsible for all debts and obligations. It also implies that their personal assets are at stake if the business fails.

Self-Employment: It is a work status where a person works for themselves and not for an employer. Self-employed individuals are their bosses responsible for managing their work, finances, and business operations. Self-employment could include freelancing, contracting, partnering, and even sole proprietorship.

You can say that "all sole proprietors are self-employed, but not all self-employed people are sole proprietors."

Let's see an example for a better understanding. Consider a chef who could be a sole proprietor if they owned a restaurant. They are also self-employed. While if a chef works on a contract basis at a restaurant, they're not the sole proprietor but self-employed as they work only as long as the contract lasts. 

In the second case, however, if the restaurant owner pays more than $600/year per contract, it must issue a tax form, Form 1099, specifying the taxable income.

How to Calculate Self-Employment Tax Deductions

Calculating your self-employment tax deductions involves the calculation of your earnings (net profit/loss) and the taxable portion. We have divided the entire process into a few simple steps mentioned below.

1. Calculate your earnings and portion subjected to the tax. 

To begin with, calculate your net earnings by subtracting total expenditure from your gross income/sales.

Net = Total Self-Employment Income - Total Business Expenses

If the net is positive, you're looking at a positive tax on profit. If you have a negative net profit (net loss), you won't owe self-employment tax, but you can still report it on your tax return to offset other income.

2. Determine the self-employment tax based on the rate.

Calculate your tax. 

Self-Employment Tax = Taxable Income x Tax Rate

Here, taxable income is 92.35% of your net earnings, as a 7.65% deduction is allowed for the contractor's portion of FICA taxes (if you were paid as a contract employee).

Otherwise, your Self-Employment Tax = Net Earnings x Tax Rate.

For example, your net earnings are $1,000,000. 

In the case of contracts, self-employment tax = 0.9235*1,000,000 x Tax Rate (15.3%).

Otherwise, self-employment tax = 1,000,000 x Tax Rate (15.3%)

3. Deduct half of the self-employment tax as an adjustment.

IRS allows you to deduct half of the total self-employment tax as the employer-equivalent portion. This reduces your overall income tax liability. 

4. Report on Tax Return

Report the self-employment tax deduction on your individual income tax return (Form 1040) using Schedule SE (Self-Employment Tax).
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Common Self-Employment Tax Deductions

Multiple write-offs/deductions that are eligible to be deducted from your income. These deductions shall reduce the amount of taxes you owe. The most standard tax deductions are enlisted below.

Home Office Expenses

Home office expenses are simply deductions of utilities you use as a part of your self-employment. If you use a portion of your home exclusively for business purposes, for example, a room for trading, you may check for home office deductions. 

Vehicle Expenses

If you have vehicles for business use, you can deduct the actual expenses of running the vehicle (fuel, repairs, or insurance) or utilize the standard mileage rate established by the IRS (65.5 cents/mile for all miles of business use).

Health Insurance Premiums

Self-employment tax also allows for self-employed health insurance deduction. This deduction is made before other standard deductions to ensure that it lowers your AGI (adjusted gross income). However, taxpayers and their spouses must not qualify for other health plans to avail of this deduction.

Internet and Phone Bills

Tax write-offs for self-employed people can also cover the internet and phone bills in addition to home office self-employed expenses. This deduction accounts for phone/internet usage while you're on the road. But you must record your data usage and then deduct the dollar equivalent of the same from your income. 

Professional Development

Self-employed deductions can also account for personal development expenses related to skill enhancement or higher education in your field of work. However, self-education expenses are not deductible if

• They have no relation to your current employment.
• These are only generally related to your current profession.
• They will help you gain/change employment.

For example, if you are working as a chef and you take photography lessons, then that expense is not a personal development expense and cannot be deducted.

Who Must Pay Self-Employment Tax?

Self-employed individuals, including sole proprietors, partners in a partnership, LLC (limited liability company) members, LP (limited partnership) members, or people with independent net earnings, pay self-employment taxes. Despite working independently, they are obligated to track their earnings. These earnings are reported through IRS Schedule SE (Form 1040) for self-employed individuals and 1099-MISC forms for contractors.

How to Pay Self-Employment Tax

Filing taxes could be challenging without professional assistance if you are unfamiliar with the forms and procedures. The process becomes more complicated for self-employed individuals like freelancers or gig workers who must calculate, pay, and file their self-employment tax. 

Don't worry; we are there to help you at every step. Below is a list of steps to file your self-employment tax.

1. Ensure that you ACTUALLY have to pay SE tax.

You're liable to pay self-employment taxes only if you're a sole proprietor, independent contractor, freelancer, small business owner, gig worker, or a side hustler with a W2 income as well. 

The bottom line is that self-employed taxes are applicable on all individually and independently earned income, whether it's your primary source of income or not.

2. Figure out your net earnings.

You must know your earnings before considering any self-employed deductions to pay taxes. If you've earned over $600, you must fill out a 1099-NEC or 1099-K form (in case you received payments via a third-party payment processor).

3. Self-employed tax deductions.

Wondering what to deduct on taxes when self-employed? As mentioned above, you can deduct 

• Internet and phone expenses,
• Home office expenses, 
• Health insurance premiums, 
• Self-development expenses, 
• Vehicle expenses. 

Once you have a rough estimate, subtract the amount from your net earnings and calculate your tax liability. 

Manage Taxes For Your Global Team with Skuad

Are you intimidated by the self-employment tax and the filing process? No need to be. All you need to do is keep accurate records of your business expenses. These expenses will allow you to deduct several tax write-offs to reduce liability. 

If you’re working with independent contractors, managing their data and taxes can be challenging and time-consuming. Besides, with international contractors on board, the process becomes even more complicated. With Skuad’s Employer of Record (EOR) platform, you can hire, onboard, pay and manage contractors and employees in over 160 countries, compliantly. 

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FAQs

Do I need to pay the self-employment tax?

If you are a sole proprietor, freelancer, independent contractor, gig worker, or some self-employed individual, you will most likely have to pay the self-employment tax.

How do I report the self-employment tax?

Self-employment tax is reported using IRS Schedule SE (Form 1040 or Form 1040-SR for seniors). The Schedule has two parts: 

• Part I: This section calculates the Social Security tax.
• Part II: This section calculates the Medicare tax.

To pay quarterly, use Form 1040-ES to calculate and submit your estimated tax payments.

Can you deduct 50% of the self-employment tax?

Yes, you can deduct 50% of the self-employment tax as an 'adjustment' to your income. This deduction is a "self-employment tax deduction" and accounts for the employer's portion of the total tax liability.