If you run a successful business and are taxed as a sole proprietor or partner, or earn a living as an independent contractor, you're self-employed. You always can take the same income tax deductions available to employed taxpayers, but because of your self-employment earnings, additional deduction opportunities exist as well. Self-employment, however, also means that you'll have to fill out more than just a 1040 form if you want to take advantage of these tax deductions.
Deductible Business Expenses
It doesn't matter what type of self-employment activities you engage in, you can always deduct ordinary and necessary business expenses to reduce the amount of your taxable earnings. The type of business you run will dictate whether an expense is ordinary and necessary, but the self-employed frequently deduct compensation paid to employees and contractors, office rent and utilities, supplies, inventory, equipment and tools, car and travel expenses, insurance premiums, interest payments on loans or credit cards, and a wide range of other costs you incur in your trade or profession. All of these deductions are taken on a Schedule C or Schedule C-EZ -- the two forms that self-employed people calculate and report taxable net profits on.
Half of Self-Employment Taxes
You have to pay self-employment taxes, which cover the Social Security and Medicare tax, when the net profit reported on your Schedule C is $400 or more. But since you don't have an employer who pays a portion of these taxes and makes payroll deductions for your share, you're responsible for figuring out what you owe and paying the full amount. Self-employment taxes are reported on a Schedule SE attachment to the 1040 form. As a self-employed taxpayer, however, you get to deduct one-half of the tax you owe as an adjustment to income on the first page of your 1040 form.
Working from Home
If you're like many other self-employed individuals and complete most of your work from home, you may be able to take the home office deduction. To do so, you must use an area of your home “exclusively and regularly” as your principal place of business. You can either deduct $5 for each square foot, up to 300 square feet, directly on your 1040 or Schedule C, or deduct a percentage -- which you determine by dividing the square footage of your work space by the total square footage of the home -- of certain housing expenses. When figuring out your deduction under this method, you'll have to file Form 8829 to report your annual property taxes, mortgage interest and depreciation or rent, utilities, insurance, as well as maintenance and repair costs. Your related business expenses, such as telephone and internet service, are deducted on Schedule C and aren't included in your home-office deduction.
Health Insurance and Retirement
As a self-employed taxpayer, you're still entitled to deduct health insurance premiums and retirement account contributions like employees are. But unlike an employee, your medical, dental and long-term care insurance policy premiums that provide you, your spouse and your dependents with coverage are deducted as an adjustment to income directly on your 1040 instead of on Schedule A. If you make contributions to a 401(k) or other tax-deferred retirement account, you can deduct as much as a taxpayer who isn't self-employed.
Michael Marz has worked in the financial sector since 2002, specializing in wealth and estate planning. After spending six years working for a large investment bank and an accounting firm, Marz is now self-employed as a consultant, focusing on complex estate and gift tax compliance and planning.