Mike Rooney

programming and philosophy

Tax Deductions for the Self-Employed

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Since becoming self-employed at the beginning of 2012, I’ve been doing a fair amount of research into the tax deductions I’m able to take. While taxes aren’t intrinsically exciting, the money they save generally is; see below for how they can add up to a million dollars for retirement. For those not self-employed, I’m sorry that this post is totally useless to you :)

One caveat before I start: I’m not an accountant and hardly an expert, so don’t take my word for it, especially since this will be my first year filing as self-employed. These deductions should apply to most business structures including Sole Proprietorships and S Corporations, though C Corporations get more complicated.

I’m going to do a really shallow overview here, as this is all covered in great detail in the book “Deduct It! Lower Your Small Business Taxes”. If you are interested in learning more or taking any of the following deductions, the appropriate chapter in “Deduct It!” has everything you need to know.

Tax Deductions are (Probably) Worth More Than You Think

Before doing research, I was previously only thinking about tax deductions as being worth 20-30% of the deducted amount, as that was the percentage of my salaried income that went to taxes before. However, a deduction is likely worth 40-50% (the higher end in places with a local income tax like SF and NYC) because:

  • the deduction comes off the top of your income, meaning it saves you money at your marginal federal, state, and local brackets.
  • being self-employed, you no longer have an employer covering half your medicare and social security taxes, so that’s another 6-7% that doesn’t get taken from what you deduct.

Also, let’s not forget the “time value of money”: if you are able to use deductions to end up with $5,000 extra dollars in your pocket each year (roughly what I’m expecting) from age 25 until 65, and invest that at 7% in something like a Roth IRA, you’ll end up with a cool tax-free million dollars (that’s $1,000,000) by age 65.

So if that has your attention, I’ll go over some of the top deductions I plan on taking for the 2012 tax year.

Home Office Deduction

This is perhaps one of the most powerful, but also most complex and controversial deductions, so I’ll grossly oversimplify it: if you work from home and can dedicate a portion of your home solely to a home office, you can deduct a percentage of your rent. For example, if you use 25% of your apartment for your home office, you can deduct 25% of your rent. This is definitely my biggest deduction, living in NYC.

You can also apply this percentage to utilities, renter’s insurance, cleaning services, and other things that benefit both the home and home office. For things that benefit just the home office (paying someone to clean just the office, repairs to just the office, and such, are 100% deductible).

Health Insurance Premiums

Health insurance premiums are 100% deductible, though not (in practice) as a business expense. This is instead a special type of personal deduction which doesn’t require itemizing, but also isn’t a deduction for self-employment tax purposes. If you file correctly, you should be able to avoid paying any federal/state/local income taxes on your premiums.

You can also look at setting up a medical expense reimbursement plan, which just requires a document kept on-record, and will allow the company to reimburse you for a very wide range of costs you’ll incur, deducting them as expenses.

Office Supplies & Equipment

Any office supplies and equipment are generally fully deductible, and often without requiring depreciation over time thanks to Section 179. This means if you purchase a desk, monitor, and laptop solely for your home office, you can deduct the full costs of these as a business expense. This also applies to smaller things such as stationary, postage, et cetera. As consumers used to paying for things post-tax, it is quite profound to be able to pay for electronics pre-tax, and effectively pay 40-50% less for them.

Don’t forget to deduct the cost of things like web hosting as well!

Independent Contractors & Services

You should also deduct the cost of any sub-contractors you might hire, or lawyers and accountants you hire to help you with your business, including tax preparation. This also includes the cost of any accounting / bookkeeping software, as well as SASS such as Freshbooks.com.

Start-Up Costs

Generally, costs you incur to bootstrap your business are deductible, though it gets more complicated if they exceed $5,000. This would include any incorporation costs (including the CA ~$800 fee), costs of using something like legalzoom.com, and accounting / consulting services used.

Okay, that’s essentially a whirlwind tour of some the most useful deductions I plan on taking! While I don’t need a vehicle here in NYC, if you have a car or travel to meet clients or perform work tasks, you should also definitely look into car and travel deductions, as those can be huge as well.

Certainly let me know if I have any misunderstandings, or if I’ve missed anything important.