Self-employment comes with many tax benefits but with tax pitfalls too

What: As the economy recovers, some people previously employed by businesses are looking to start businesses of their own. Taxpayers who operate their own business, whether as a sole proprietor or organized as another business entity, are entitled to many more tax breaks than individual taxpayers and also some additional tax obligations. Many of those tax breaks come with complicated rules and require careful documentation.

Why: Self-employed individuals will want to understand the rules applicable to them and seek professional tax assistance to maximize their eligibility for tax breaks. Failure to understand the requirements can result in the loss of those tax breaks. Typically, the Internal Revenue Service (IRS) also audits a higher percentage of returns of self-employed taxpayers, as compared to individual taxpayers, because of the potential to try to claim personal expenses as business deductions.

Self-employed tax deductions can include ordinary and necessary expenses of operating the business, such as:

• Home office expenses or rent
• Travel expenses, including vehicle expenses, other transportation expenses, lodging, and special rules for meals
• Premiums for insurance to protect the business
• Health insurance premiums
• Interest on business loans
• Business-related expenses such as start-up costs, advertising, office supplies, internet and phone bills, repairs and maintenance, publications and subscriptions, education, or tax preparation fees
• Retirement plan contributions
• The new 20 percent Qualified Business Income Deduction under the Tax Cuts and Jobs Act
• Several deductions were also eliminated under the Tax Cuts and Jobs Act, including entertainment and fringe benefit deductions

Self-employed individuals also face a few additional tax obligations.

• Paying self-employment taxes, including both the employer’s and employee’s share, although it comes with a deduction for the employer’s half of the cost
• Paying estimated tax payments because self-employed individuals typically are not subject to tax withholding
• Requirements to file Form 1099s for certain payments

The risks in not adhering to the “rules” for claiming self-employed tax deductions can be illustrated by the recent Tax Court case of Baum v. Commissioner, TC Memo. 2021-46, 121 T.C.M. 1315.

• Loss of deductions for travel, meals, and lodging for failure to provide substantiation to support the amount, time, and business purpose of the expenses
• Loss of a theft loss deduction from an investment that went bad for failure to show it constituted a theft in the state in which the loss occurred, failure to show it related to the trade or business, and failure to prove the amount of the loss or the year in which it was sustained
• Penalties for late return filing due to failure to prove it was due to reasonable cause

Who: Tax expert Mark Luscombe, JD, LL.M, CPA, Principal Federal Tax Analyst at Wolters Kluwer Tax & Accounting, can help discuss the tax breaks available to self-employed persons.

PLEASE NOTE: These materials are designed to provide accurate and authoritative information in regard to the subject matter covered. The information is provided with the understanding that Wolters Kluwer Tax & Accounting is not engaged in rendering legal, accounting, or other professional service.

Contact: To arrange interviews with Mark Luscombe and other federal and state tax experts from Wolters Kluwer Tax & Accounting on this or any other tax-related topics, please contact Bart Lipinski.