For the self-employed, deductions related to business expenses are not necessarily found all in one place. While the Schedule C is an important form for the independent contractor or sole proprietor, self-employment deductions taken in other parts of the income tax return should not be overlooked.
This list of self-employment deductions includes brief descriptions and the forms on which they are found, but its purpose is not to give specifics but to help you recognize potential self-employment deductions in the daily course of business. For detailed instructions and conditions for these self-employment deductions, consult a tax specialist or IRS publications.
1. Half of Your Self-Employment TaxWhen employed, your employer pays half your Medicare and Social Security taxes, and you pay the other half through payroll taxes. When you are self-employed, you must pay all of it, through self-employment tax. However, as your own employer, you are entitled to deduct half of it.
Deduction or not, though, self-employment tax can be a big cost for an independent contractor. Knowing how self-employment tax is calculated is important when considering employment versus contracting. Also remember that Schedule C deductions reduce your business's net income and therefore self-employment tax too.
To calculate self-employment tax, use Form SE, but it is paid and half is deducted on your 1040.
2. Use of Your Home Office
Taking a home office deduction can be an important self-employment deduction, but there are a many IRS rules regarding this deduction. In general, deductible home office expenses are related to the use of your home office--not equipment in the office--and are partially deductible in proportion to the amount of space the office takes up within the home and the amount of income earned there. For more details, read this Home Office Deduction FAQ. To calculate the deduction for use of your home office, use Form 8829. The deductible amount is then entered on your Schedule C.
3. Rent and Mortgage Interest
If you rent office space or own facilities that you use in your business, rent and mortgage interest are deductible on Schedule C. However, this self-employment deduction is limited to space outside your home. Home office deductions of rent and mortgage interests, as mentioned above, are only partially deductible and calculated on Form 8829.
4. Utilities, Internet and Phones Costs
If you own or rent office space outside your home, utilities are fully deductible on Schedule C. Again for home offices, these are mostly considered indirect expenses and are only partially deductible. Utilities might include gas, electric and security systems.
Phones used for business are legitimate self-employment deductions. This includes cell phones for business use and second phone lines in your home office. However, you cannot deduct the base cost of your home phone line, though you can deduct the cost of business calls made on it. These are deductible on Schedule C.
5. SuppliesThe supplies you use to run your business are deductible on various lines of Schedule C. Consumable office supplies like toner, paper, envelopes, etc., are deducted in Part II of Schedule C. (Equipment, such as computers, cameras, printers, calculators, etc., are deducted separately. See below.) Be sure to keep these items separate from those you have for personal use and keep your receipts organized.
These types of incidental supplies are deducted separately from the raw materials you use if your business is one that makes and sells goods. See Part III of Schedule C for deducting the cost of raw materials and merchandise.
Office equipment, tools or machinery are deducted on Line 13 of Schedule C, or the "Depreciation and Section 179" line. First, use Form 4562 to figure the depreciation. This is the form you use whether you are depreciating the equipment over multiple years or in one year using a Section 179 deduction.
7. Repairs and Maintenance
This includes the cost of actual repairs as well as service contracts for business equipment and your office. These are taken on Schedule C. Remember though, if you did the work yourself on the repair, you cannot deduct the labor cost--only materials. Deductions for repairs to a home office are calculated on Form 8829. If a repair is made on another part of your home that affects your home office (i.e., the furnace), it is likely an indirect expense and only partially deductible.
8. Retirement Plans
When you are employed, contributions (within the established limits) to retirement plans reduce your taxable income on your 1040, even if you don't itemize deductions. The same is true for the self-employed. You can establish individual retirement accounts (IRA), such as SEP or SIMPLE IRAs, for yourself and/or employees. If you establish a new retirement plan for employees, you may be eligible for a tax credit for the first three years. (See IRS Publication 560 for details.) For yourself (but not your employees), you may use a traditional IRA to make contributions.
9. Self-Employed Health Insurance Premiums
In order to deduct self-employment health insurance premiums for yourself and your family, you must have a net profit on your Schedule C, and you must not be eligible for coverage on another plan (e.g., your spouses' plan). Other restrictions for self-employed health insurance deduction also apply. This deduction is taken on your 1040.
10. Other Insurance
This would include business, property, liability, malpractice, worker's comp insurance, etc. If you have a home office, a portion of your homeowner's insurance is deductible as an indirect expense on Form 8829. If you use a personal vehicle for business, you may deduct a portion of auto insurance, if you are figuring actual expenses rather than taking the standard mileage. These are taken on Schedule C, except for the homeowner's insurance, which calculated on Form 8829 as mentioned above.
11. Employee Wages and Benefits and/or Payments to Contractors
You can deduct the cost of labor from independent contractors and employees on Schedule C. However, these self-employment deductions are on separate lines: contract labor (Line 11) and salaries and wages (line 26). If you provide benefits to your employees, such as health insurance and life insurance, these too are deductible. Remember though your own health insurance premiums are deducted separately, as mentioned above.
Just as you may deduct your employer portion of Medicare and Social Security for yourself, you can deduct these taxes for your employees. However, unlike your own taxes, employees' payroll taxes are deducted on Schedule C. Additionally you can deduct sales tax paid as the seller of goods, unemployment taxes, and fees for licenses and permits as well. Property taxes on real estate used exclusively for business purposes are deductible. The property tax on a home in which you have an eligible home office is partially deductible.
Just as mortgage interest for real estate used for business is deductible, other types of interest are deductible as well. This includes financing costs and credit card interest. However, to calculate this interest it is best to have separate credit cards for your business expenses. This is deducted on Schedule C.
14. Advertising, Promotion, Dues and Subscriptions
These might include the cost of advertising, websites, business cards, brochures, mailings, membership to business organization, professional journal subscriptions. They are deductible on various lines of Schedule C.
15. Business Travel
The IRS defines business travel expenses as "the ordinary and necessary expenses of traveling away from home for your business, profession, or job." The purpose of the trip should be primarily business not personal. And expenses for family members traveling along are not deductible. Deductible travel expenses may include transportation, car, lodging, meals and incidental costs. Note that employees use Form 2106 to report business travel expenses; however, self-employed persons report it on Schedule C.
16. Meals and Entertainment
Meals and entertainment business expenses are usually 50 percent deductible. These expenses might include entertaining a client in your local area or meals while traveling on business. These are deductible on Schedule C. Jean Murray, About.com Guide to U.S. Business Law/Taxes, list this deduction as one of 5 Red Flags That Trigger Business Tax Audits.
17. Transportation and Auto Expenses
Commuting costs are not deductible; however, if your home office is your principal place of work traveling to other sites where you do business may be deductible. When deducting automobile expenses (Schedule C, Line 9) you can either take the standard mileage deductions or you can calculate actual expenses and depreciation and multiply that by your business use percentage. Either way you need to keep accurate records of your business vehicle use. Parking fees and tolls are added to these figures before entering them on Line 9. Depending on your particular situation you may need to file a Form 4562.
18. Professional ServicesLegal fees and tax preparation costs for your business are deductible on Schedule C. However, the cost of having your personal income tax prepared is not deductible, so have your accountant itemize his or her fees.
19. Business Bad DebtsIn order to write of a bad business debt (which is one that stems from operating your business), you must be using the accrual method of accounting, which means you report your income as it is earned not as paid. Because most small companies, independent contractors and freelancers use the cash accounting method,this is not a very typical self-employment deduction--but useful to know nonetheless. Bad debts are deducted in Part V of Schedule C.
I am not a tax attorney, CPA or tax preparation specialist. The information here is meant as a general guide. For specific questions about your own taxes, please refer to IRS publications or consult a tax specialist.