Top 5 Tax Deductions You Can Take in 2020 if You’re an Independent Contractor
Deduction #1: Home Office
One of the most utilized aspects of self-employment can also be one of the more complex deductions. Whether you rent or own your regularly used workspace, you may deduct it as a home office expense. While you are more or less on the honor system in this case, you should always be prepared to provide proof of your deduction in the event of an audit.
Additionally, the expenses associated with your mortgage or rent, cost of utilities and insurance can be deducted for the use of your home office. For example, If your space of business occupies 10 percent of your home, then 10 percent of your annual electricity bill can be tax deductible.1 Keep in mind that some of these deductions apply only to homeowners rather than those who rent their home office space.
If you’re someone who works from home or uses part of it for your business, a few key deductions could catch you a cost break in the long run.
Deduction #2: Health Insurance
As someone who is self-employed, you more than likely pay for your own health insurance (unless you are eligible to participate in a spouse’s employee plan). As such, you are able to deduct your health, dental and qualified long-term care insurance premiums. You are also able to deduct medical and dental insurance for your spouse, your dependents and children younger than 27 at the end of the year.2 To accurately calculate your deduction and gain further insight, use the IRS Publication 535.
Keep in mind that as an adjustment to income as opposed to an itemized deduction, you don’t necessarily need to itemize in order to claim. It’s important to note that if you are eligible to enroll in a spouse’s employee plan and choose not to for any reason, you will not be unable to take this deduction.
Deduction #3: Education
If you plan on deducting any expenses related to education, they must be related to maintaining or improving your knowledge and skills associated with your current business (this means if you’re interested in branching out and learning about something new, the associated classes or coursework won’t be deductible). If you are furthering your education with coursework related to your industry, then items such as tuition, supplies, lab fees and other related expenses may be deductible. Requirements can be reviewed using the IRS website.
Deduction #4: Travel
In order for business travel to qualify as a tax deduction, it must be longer than an ordinary workday, take place away from the general area of your home and require you to sleep or rest. Furthermore, you must engage in business activity during such a trip in order for it to be considered business-related. Whether you’re meeting with customers or gaining insight or skills related to your business, the travel must be associated in some way.3 It’s important to hold on to receipts and records during these trips as the IRS often keeps a close eye on this form of deduction.
Some of the expenses that may be considered deductible during travel include the cost of transportation (such as airfare or car rental), lodging and associated meals. While you don’t need to book the cheapest options, you won’t be able to deduct outlandish expenses. As with any trip, it’s important to keep your costs reasonable as you are the one paying the majority of them.
Traveling for business often takes a toll but being able to deduct 100 percent of your travel expenses for business (except for meals, which are limited to 50 percent) can help make the effort less stressful.3
Deduction #5: Retirement Savings
When it comes to retirement, you have a fair amount of options as a self-employed individual. Taking into consideration your contributions to an IRA or solo 401(k) plan can help you gain tax-deferred investments down the road.
As someone working for themselves, you can contribute to a solo 401(k) plan of up to $57,000 in 2020 ($64,500 if you’re 50 or older) or 100 percent of your earned income, whichever is less. Similar to a standard, employer-sponsored 401(k), your contributions are pre-tax and distributions after age 59½ are taxed.4
This benefit will only help if you have the opportunity to take advantage of it and keep in mind that you can’t contribute more than you earn. Your specific retirement plan type may contribute to varying contribution limits and the IRS also adjusts associated maximums on an annual basis.
The Bottom Line
While most self-employed or small business tax deductions are complicated, being aware of these basics can help ensure you don’t leave any valuable deductions on the table. By keeping in mind whether an expense is necessary to your business operations you’ll be on the same page as the IRS as they examine your deductions. If you’re ever unsure of an expense and it’s deduction capabilities, or if you simply want a tax strategy to optimize your earnings, meeting with a financial advisor or accountant is good idea.