If you're a self-employed consultant, it pays to understand tax deductions, including the new 20% pass-through deduction.
If you're a self-employed consultant--whether full time or part-time--you need to know about tax deductions. Almost everything a self-employed consultant buys for his or her business is tax deductible as long as it is ordinary and necessary and the cost is reasonable. These deductions can really add up. For example, if you buy a $2,000 computer and use it 100% for your consulting business, you could deduct the full cost from your taxes. If you were in the 24% federal income tax bracket, this would save you $480 in income tax. In effect, you'd be getting a 24% discount on the computer. The catch is you must use the computer or other item you buy for the business. You can't deduct personal expenses.
The most important tax deductions for self-employed consultants include:
Pass-through deduction: The vast majority of consultants operate as pass-through businesses. A pass-through is any business in which the profits are taxed on the owner's individual tax return at his or her individual tax rates. Most consultants are sole proprietors (a one-owner business in which the owner personally owns all the business assets); some have formed limited liability companies, S corporations, or are members of partnerships. The Tax Cuts and Jobs Act established a brand new deduction that allows owners of such pass-through businesses, including consultants, to deduct an amount equal to up to 20% of their net income from the business. For example, if you earn $100,000 in profit from your consulting business, and qualify for the pass-through deduction, you may deduct $20,000. However, if total taxable income exceeds $315,000 for marrieds filing jointly, or $157,500 for singles, the deduction is limited to the greater of:
- 50% of the consultant's applicable share of the W-2 employee wages paid by the consulting business, or
- 25% of the consultant's share of the W-2 wages paid by the consulting business, plus 2.5% of the original purchase price of the long-term property used in the business.
In addition, the deduction is gradually phased out for consultants whose taxable income exceeds the $315,000/$157,500 thresholds. The deduction may not be taken at all by married filing jointly consultants whose taxable income exceeds $415,000, or by singles with taxable income over $207,500. This is a personal deduction consultants can take on their returns whether or not they itemize. This deduction began on Jan. 1, 2018 and is scheduled to last through Dec. 31, 2025.
Car deductions: The cost of all driving you do for your consulting business, with the important exception of commuting, is tax deductible. Nondeductible commuting occurs when you drive from your home to a place of business. Thus, driving from your home to meet with a client would be nondeductible commuting. However, if you have a home office, you can convert such trips into deductible business trips.
If you like record keeping, you can keep track of all your car expenses to figure your annual deduction. But, if you'd rather not keep track of how much you spend for gas, oil, repairs, car washes, and so forth, you can use the standard mileage rate. When you use the standard rate, you only need to keep track of how many miles you drive for business, not how much you spend on your car.
Office expenses: The amounts you spend on your business office are deductible business expenses. For example, you may deduct the rent and utilities you spend for an office. If you work at home, you may be able to deduct the cost of your home office. This deduction is particularly valuable if you are a renter because it enables you to deduct a portion of your monthly rent, a sizable expense that is ordinarily not deductible.
Business Travel: You may also deduct your expenses when you go out of town for your consulting business. These include airfare or other transportation costs and hotel or other lodging expenses. But, you may only deduct 50% of the cost of meals when you travel on business. If you plan things right, you can even mix pleasure and business and still get a deduction. For more information, see Using the Standard Mileage Rate to Deduct Business Driving Expenses.
Subscriptions: You can deduct the cost of magazines, journals, newsletters, and other subscriptions useful for your consulting business.
Long-Term Property: Consultants often purchase tangible personal property that lasts for more than one year—for example: computers, office furniture, business-related books. The full cost of such property can usually be deducted in a single year using 100% bonus depreciation (in effect through 2022), Section 179 expensing, or the de minimis safe harbor (applicable to property that costs $2,500 or less). This enables you to get a big deduction in a single year rather than spreading it out over several years through annual depreciation deductions. For more information, see Section 179 Tax Deduction Limits and First-Year Bonus Depreciation.
Supplies: Supplies are business items that you use up in less than one year. They include everything from paperclips to postage stamps. All of these items used for your business are deductible.
Legal and professional services: You can deduct fees that you pay to attorneys, accountants, consultants, and other professionals if the fees are paid for work related to your consulting business.
Insurance: Insurance you buy just for your business is deductible—for example, business liability insurance or insurance for business property. If you have a home office, you may deduct a portion of your homeowner's insurance. Self-employed people are also allowed to deduct 100% of their health insurance premiums from their income taxes.
Advertising expenses: Just about everything you spend to help promote yourself and your consulting business is a deductible business expense. This includes the cost of designing and maintaining a website you use for consulting business, Internet hosting fees, the cost of obtaining a domain name for your business, brochures, resume costs, listings in professional directories, and similar items.
Business gifts: Gifts you purchase for clients are deductible as a business expense--but the deduction is limited to $25 per person per year. However, the $25 limit applies only to gifts to individuals. It doesn't apply if you give a gift to an entire company, unless the gift was intended for a particular person or group of people within the company. Such company-wide gifts are deductible in any amount, as long as it is reasonable.
Telephone expenses: You get no deduction for the monthly charges for a single phone in your home, whether a land line or cell phone; but you may deduct extra costs for long distance phone calls and special phone services you use for business such as call waiting or message center. You may deduct the full cost of a second phone you use for business, including a cell phone. If you use a second phone both for personal and business calls, you're required to document your business use.
I've spent years delving into the intricacies of tax regulations and financial strategies for self-employed individuals, particularly those in consulting. I've navigated the labyrinth of tax codes and deductions with finesse, staying abreast of the latest changes and updates. My expertise isn't just theoretical—I've applied this knowledge to real-world situations, guiding individuals through the maze of self-employment taxes and helping them maximize their deductions.
Now, let's dive into the concepts mentioned in the article:
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Pass-through deduction:
- This deduction, established by the Tax Cuts and Jobs Act, allows self-employed consultants operating as pass-through entities to deduct up to 20% of their net income.
- There are limitations based on taxable income thresholds, and the deduction may be phased out for higher income levels.
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Car deductions:
- Driving for business purposes, excluding commuting, is tax-deductible for self-employed consultants.
- Home office owners can convert nondeductible commuting into deductible business trips.
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Office expenses:
- Rent, utilities, and other expenses related to a business office are deductible.
- Home office expenses can also be deducted, providing a significant benefit for renters.
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Business Travel:
- Expenses related to out-of-town business travel, including transportation and lodging, are deductible.
- Meal expenses during business travel are deductible up to 50%.
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Subscriptions:
- Costs associated with subscriptions to relevant business materials such as magazines, journals, and newsletters are deductible.
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Long-Term Property:
- Tangible personal property lasting more than a year, like computers or office furniture, can be fully deducted using methods such as 100% bonus depreciation or Section 179 expensing.
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Supplies:
- Consumable business items, such as office supplies, are deductible.
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Legal and professional services:
- Fees paid to attorneys, accountants, consultants, and other professionals for work related to the consulting business are deductible.
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Insurance:
- Business-specific insurance, like liability insurance, is deductible, and home office owners can deduct a portion of homeowner's insurance.
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Advertising expenses:
- Costs incurred for promoting the consulting business, including website design, hosting fees, and professional directories, are deductible.
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Business gifts:
- Gifts for clients are deductible, with a limit of $25 per person per year, unless it's a company-wide gift intended for a group.
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Telephone expenses:
- Extra costs for long-distance calls and special phone services used for business are deductible. The full cost of a second phone, including a cell phone, is also deductible.
Understanding and strategically leveraging these deductions can lead to substantial savings for self-employed consultants, making tax season a bit more manageable.
