5 Tax Considerations for Self-Employed Individuals

By: Stacey Nickens

Deciding to become your own boss can be incredibly meaningful and freeing. As a self-employed person, you have much more control over your day-to-day schedule, your business structure, and so much more. At the same time, costs that were previously covered by an employer now become your responsibility, including costs associated with health insurance, retirement plan contributions, and business travel. Additionally, you are now on the hook for the self-employment tax.

1. Self-employed individuals must cover both the employee and employer’s portion of Social Security and Medicare taxes by paying the self-employment tax. The Treasury Department uses self-employment tax to collect Social Security and Medicare taxes from non-wage, business-related income. For the 2022 tax year, self-employed individuals will pay a 15.3% tax on their first $147,000 of self-employment income. This tax includes…

• A 12.4% Social Security tax
• A 2.9% Medicare tax

Income above $147,000 is not subject to Social Security tax; however, self-employed folks will still need to pay the 2.9% Medicare tax on income between $147,000 to $200,000/$250,000 (single filers/joint filers). Beyond the $200,000/$250,000 threshold, you pay a 3.8% tax on income. This tax is comprised of the 2.9% Medicare tax plus an additional 0.9% Medicare tax for high earners.

Normally, your employer would cover half of your Social Security and Medicare taxes, and you would pay the other half. When you’re self-employed, you’re both the employer and the employee, and thus you pay both halves of the Social Security and Medicare taxes, resulting in higher taxes.

2. To recoup funds from this double taxation, self-employed filers can deduct half of their 12.4% Social Security tax and half of their 2.9% Medicare tax on their return. However, self-employed filers cannot deduct half or any part of the 0.9% Medicare tax imposed on higher earners.

3. You can deduct contributions to a self-employed retirement plan. You have a number of retirement plan options, including a SEP IRA, 401(k) plan, or SIMPLE IRA. Not only will contributing to one of these plans reduce your taxable income, it will also set you up for success in retirement.

4. Self-employed folks can claim a number of other deductions.

• You will likely be able to claim an above-the-line deduction for health insurance premiums as long as you are a sole proprietor, LLC member treated as a sole proprietor or partner on your return, a partner in a partnership, or an S Corporation shareholder-employee. You cannot claim this deduction if you are eligible for subsidized health insurance, such as through a spouse.
• You can deduct 100% of business meals during 2022.
• You can claim depreciation on certain heavy vehicles used for business purposes. Qualifying heavy vehicles include SUVs, pickups, and vans that are purchased and put into service between September 28, 2017 and December 31, 2022. As long as more than 50% of the vehicle usage is for business purposes, you can claim 100% first-year bonus depreciation on the vehicle. If 50% or less of the vehicle’s usage is for business purposes, you can depreciate the vehicle’s cost over the course of six years.
• You can deduct many home office expenses as long as your home office is considered your “principal place of business.” Your home office qualifies as your principal place of business if a majority of your income-earning activities occur at your home. Some expenses, including home office repairs, are fully deductible, while other expenses, such as mortgage expenses, are partially deductible. You would calculate your home office’s percentage of your home’s total square footage and use that percentage to calculate the deductible portion of your utilities, property taxes, and other residential fees and costs.
• If your home office qualifies as your principal place of business, you can deduct business mileage when driving to other work locations. Deductible mileage rates increased this year due to rising gas prices, and self-employed folks may benefit from these higher rates.

5. Finally, you can likely claim the Qualified Business Income (QBI) Deduction. Through 2025, the QBI deduction can be up to 20% of…

• QBI earned from a sole proprietorship or single-member LLC
• QBI passed through from a partnership, multi-member LLC, or S corporation.

Beginning in 2022, the QBI deduction begins to phase out when your income exceeds $340,100 for joint filers or $170,050 for other filers.

Overall, tax planning for small businesses and self-employed individuals can be complicated. Developing a strong business plan requires comprehensive tax planning. Our experienced tax team would be happy to assist you as you develop your business and plan for your tax burden.

Sources: Bradford Tax Institute