Cypress Wealth Services
As autumn approaches with a promise of cooler temperatures, we find it’s the perfect opportunity for the self-employed professional to reflect on the past year’s business successes or learning lessons, and prepare for tax filing season.
Good record-keeping is at the root of saving big on taxes; there’s just no way around it. Maintaining a robust system for tracking and supporting your income and expenses will allow you to maximize tax-saving business deductions and credits. As you read through our tips, take note of how easily you’ll be able to gather the documentation needed by your tax professional. Start making improvements now and you’ll make the tax preparation process smoother this year, plus have a system in place to optimize your savings in the years to come.
Hand-in-hand with good record-keeping is the importance of establishing a system for staying on track with quarterly estimated tax payments. Income taxes must be paid as you earn or receive your income during the year, either through withholding by your employer or by making estimated tax payments. Self-employed taxpayers are responsible for paying estimated tax payments quarterly for both income tax and self-employment taxes. The penalties and interest incurred for late or missing payments or underreporting your income are costly and entirely preventable with an organized system for staying on schedule with quarterly payments.
Business profit or loss is reported as additional income on your tax return and is used to calculate self-employment taxes. Therefore, the benefit of claiming all your allowable business expenses is significant.
Some common examples of business expenses include:
Tax-deductible business expenses need to be ordinary and necessary to operate your business. Consult your tax professional for more details on qualified business expenses.
A notable difference in taxation between a self-employed professional and an employee is the FICA tax, which funds Social Security and Medicare. Paying FICA taxes is mandatory for employers and employees. The self-employed are effectively both an employer and employee, thus pay both portions as self-employment taxes. In 2021, self-employed professionals with net earnings of $400 or more pay a 12.4 percent Social Security tax on up to $142,800 of net earnings and a 2.9 percent Medicare tax on all net earnings.(*1) Reducing your net earnings by deducting all allowable business expenses can result in significant savings in self-employment taxes. However, in years with losses or low net profits, make sure to consult your tax professional and ensure you’re paying enough self-employment taxes to qualify for credit toward Social Security benefits.
Self-employment presents an opportunity for additional tax deductions whether you itemize deductions or not.
Half of the employment taxes you paid, constituting the employer portion, are deductible from your taxable income.
Contributions to a qualified retirement plan, such as a solo 401(k) or SEP IRA, are deductible for self-employed professionals. Not only can you benefit from the tax deduction, but also from higher contribution limits on some plans compared to an employer-sponsored plan. For example, with a SEP IRA, you can contribute as much as 25% of net earnings with a total contribution limit of $58,000 for 2021.(*2)
You may be eligible to deduct premiums you paid for medical, dental, and qualified long-term care insurance policies for yourself, your spouse, and dependents as long as you weren’t eligible for coverage under an employer-sponsored plan for you or your spouse.
The qualified business income (QBI) deduction, or pass-through deduction, allows many self-employed professionals to deduct up to 20% of their qualified business income from federal income tax. However, navigating QBI eligibility and calculating the deduction can be tricky due to limitations on taxable income depending on the type of trade or business, so it’s best to consult with your tax professional.
Presented here is an overview of common ways to save on taxes for self-employed professionals, but meeting with your financial planner for a comprehensive look at your unique business is truly the best strategy to save big on taxes. Your financial planner can advise you on long-term tax planning strategies and update you on IRS changes from year to year. Some self-employed professionals may benefit from changing their ownership type to an S corp, for example. Additionally, tax credits specific to your business and new tax credits due to the COVID-19 pandemic may also apply to you.
To ensure you have the best plan possible for your business, contact one of our offices today.
About Cypress Wealth Services
Cypress Wealth Services is an independent RIA firm providing financial planning and investment management to high net worth individuals, families, business owners, and institutions. Cypress Wealth Services comprises professionals with diverse backgrounds and extensive experience and qualifications. Cypress Wealth Services is uniquely qualified to serve a broad range of client needs, and their experience and expertise act as a foundation for their client service process. The firm uses The Second Growth, which focuses on efficiently protecting, growing, and transferring to their loved ones the wealth and legacy a person has already built. With financial advisors in Palm Desert, CA, Tustin, CA, and Anchorage, AK, the firm serves clients across the country in Wealth Management Services, Fiduciary Services, 401(k) Design and Management, Investment Reporting Services, Financial and Retirement Planning, and more. For more information, visit www.CypressWS.com or call 760.834.7250.