The difference between a big tax bill at the end of the year and a rebate often comes down to two very important steps.
For the self-employed, rebates require proper planning throughout the year, making sure you’re paying (without overpaying) the IRS every quarter. Second, it demands that you’re taking the right exclusions, deductions and credits come tax time. These will reduce the amount you owe.
For those self-employed or working as a freelancer, these deductions can easily be overlooked, resulting in thousands of dollars in extra taxes.
The answer to incorporating these breaks isn’t always an accountant. They can have up to hundreds of clients every year, resulting in potential oversight on their part. It requires you taking a close look at the return they produce. Meanwhile, if you’re filing on your own through an online tool, then you may not realize that you can take certain deductions that lower your bill.
Whether you’re filing with an accountant or doing it on your own, make sure to check on these deductions that can often get overlooked.
Qualified Business Income Deduction
Wrapped within the Tax Cut and Jobs Act passed in 2017 was a significant incentive for certain small businesses, sole proprietors and freelancers. Called the qualified business income deduction, this allows you to take up to 20% from your adjusted gross income (or income after expenses), providing a powerful way to reduce your taxes.
Not every small business qualifies for the deduction. First, you must have your business set up as a sole proprietorship, partnership, S corporation or limited liability company (LLC). If you have it set up as a C corporation, then you wouldn’t qualify. Essentially, it requires you to have a business that’s set up as a pass-through entity, or one that you pay taxes at the individual level as opposed to the business.
There’s also an income limit. If you made more than $164,900 for single filers or $329,800 for joint filers in 2021, then you may not be able to use the deduction. Over that income mark, then it depends on the type of business you run. For those running service businesses, then you won’t qualify. This would include consultants, which many freelancers or sole proprietors identify as. It also includes those working in accounting, law, financial services and performing arts, among other professions.
Check Your Qualified Plan Contributions
Those working for an organization and have a W2 have it easy when it comes to managing the forms for tax time. The W2 lists all the taxes they paid throughout the year and excludes all the contributions the taxpayer made to a 401(k) or other qualified plan, resulting in assurance it won’t be included in income. That’s not the case for those working for themselves.
If you have a business entity, then you can open a business qualified retirement plan, which can serve as your 401(k). These have various rules and limitations, depending on the one you select, but they range from SEP IRAs, solo 401(k)s and Keogh plans. How much you can contribute yearly will depend on the plan you select, the size of your business and whether or not you have any employees. But what you can contribute can also provide you an important tool for deduction at the end of the year.
Unlike W2 employees though, there’s space on the tax forms that sole proprietors and small business owners (with pass-through entities) use to file taxes to account for the qualified plan contribution. This is separate from your itemized deductions, and you’ll want to account for it, if you contributed during the year.
For someone that contributed $19,500 (the 2021 limit for regular or W2 401k participants) in the 24% tax bracket, it’s an equivalent to a more than $4,600 credit.
The Self-Employment Tax Deduction
One of the biggest tax hits that the self-employed must manage is the self-employment tax. This tax simply covers the amount that would normally be taken out for Social Security and Medicare if you worked for an organization. But for those with a W2, they only have to pay half of the 15.3% that individuals pay for Social Security and Medicare. The company they work for covers the other half.
If you work for yourself, however, you must cover the entire 15.3%. But, since you’re the company, you also may deduct half of your self-employment tax, or 7.65% of what you pay.
An accountant will not likely miss this deduction since they will also have to determine the tax. If you’re filing on your own, though, you don’t want to miss out on deducting half of the amount to ease the self-employment burden.
As a deduction, while it doesn’t serve to cut your taxes to the amount that a W2 employee will pay, it does provide some relief. And by accounting and double-checking every little benefit, then tax time won’t come with as big of a bill come April 15.