Four great tax breaks for the self-employed (including gig workers)
Side hustles are great for bringing in a little extra income. But they’re also a big help at tax time. That’s because people who are self-employed — even if that self-employed work is only a few hours a week — get a litany of federal tax deductions that are not available to employees.
A few of these breaks are nothing much to crow about, but a certain four can save you thousands of dollars in federal income tax.
To explain, the Tax Cut and Jobs Act of 2017 eliminated many itemized deductions for employees. However, it kept and improved tax breaks for small businesses, including sole proprietors. If you have self-employment income, whether that’s rental income through Airbnb or tutoring pay from Wyzant, these tax breaks apply to you.
For the most part, the breaks are modest. For instance, self-employed workers can subtract business-related expenses from business revenue and pay tax only on the net earnings. This allows Uber and Lyft drivers to deduct the cost of gas, maintenance, repairs and car washes, among other things, on their taxes. However, since those are all costs of doing business, these deductions only help defray a portion of your costs.
However, some tax breaks for the self-employed allow deducting expenses that are normally considered personal or provide benefits that go above and beyond recovering some basic costs. (This piece deals only with federal income tax. State tax rules can differ.)
If a portion of your home or apartment is used exclusively for your work, you can take a home-office tax deduction. This deduction allows you to write off a portion of your rent or mortgage payments, as well as part of your utility bills, maintenance costs, property tax and other expenses.
Let’s say, for example, that you live in a two-bedroom apartment that has 1,000 square feet of living space. Your rent is $1,000 a month and you’ve converted one 250-square-foot bedroom into an office that you use exclusively for work and work storage.
Because that office commands one-quarter of your space, you can deduct one-quarter of your rent — $250 per month — as a home-office expense. That adds up to a $3,000 deduction for the full year, which would save someone in the 25% tax bracket $750 in federal income tax. Additionally, one-quarter of your utility expenses is deductible too.
Any other costs you paid to set up and maintain your office — desks, computers, chairs, printers, software, etc. — are also deductible expenses for the self-employed, regardless of whether you take the home-office deduction.
For homeowners, the home office deduction gets far more complex. In this case, you get to “depreciate” a portion of the value of your home and write off a share of your property taxes, insurance and maintenance costs. But if you eventually sell your home, you will then need to “recapture” the portion of the home that you depreciated.
If your home is expensive or your home office is big, this may be worth the trouble, but you should enlist the help of a tax accountant to get the details right.
There is an alternative, however: The Internal Revenue Service provides a safe-harbor home-office deduction that amounts to $5 times the number of square feet of the home office, up to 300 square feet. That’s a maximum deduction of $1,500 — possibly lower than you’d get if you went the depreciation route, but this way you won’t have to “recapture” anything.
The catch: If you’re audited, you’ll need to show the IRS that the office was used for nothing but work.
In this age of stay-at-home orders, is this deduction available to employees who work from home? No. The 2017 tax law stipulates that it’s only for the self-employed.
Another big deduction that’s available to those with self-employment income: write-offs for health insurance premiums.
Self-employed individuals who buy health insurance for themselves and for certain family members can deduct 100% of those annual premiums. So if you’re paying $500 a month, you have a $6,000 deduction for the year that would save someone in the 25% tax bracket $1,500.
You can also deduct the cost of a qualified long-term care policy for you, your spouse or your dependents.
If you rent out a spare bedroom through Airbnb or rent out your house by the hour to photographers and filmmakers — say, through sites such as Giggster and Peerspace — you should know about the 14-day rule. In a nutshell, this rule says that income from renting out your personal residence for 14 days or less is tax-free for federal income tax purposes. If your state conforms with federal tax law, and many do, the income is free from state tax as well.
It doesn’t matter whether the rental brought in $500 or $50,000 during those 14 days. As long as the home qualifies as your residence and you don’t rent out your home for a single day more, none of this income is subject to federal tax.
However, if you rent out the home for even one extra day in that same tax year, all the income goes back into the taxable column. So think twice before accepting longer bookings.
Paying your kids
Another funky but highly lucrative tax break allows self-employed people to hire their own kids — even really young kids — and deduct all the money they pay them.
The child doesn’t need to pay any tax on this income until he or she earns more than the standard deduction for a dependent. That standard deduction amounts to $12,400 in 2020, according to Mark Luscombe, principal tax analyst with Wolters Kluwer.
What does this do? It takes income out of the presumably higher-earning self-employed person’s tax bracket and moves it to a low- or no-tax recipient. Since that recipient is your child, you can also dictate (to some degree, at least) what he or she does with the pay. You might, for example, require the child to save a portion for college or use the money to pay personal expenses that you might otherwise shoulder.
You do, however, need to pay a reasonable amount for the service your child is providing. And you should be able to justify the business need.
What would be legit? Hiring your 15-year-old computer whiz to handle updating and troubleshooting your business website. If you’d pay outside help $1,000 a month for that, that’s a reasonable amount to pay your child too.
Some business owners say they’ve hired their kids to model for their advertising, stuff envelopes, deliver packages and answer phones and email.
Notably, if you pay less than the $12,400 annually, your child won’t pay any income tax on the money. And if the child is younger than 18, this employment arrangement is also exempt from Social Security and Medicare taxes.
One final note: Keep good records. Tax audits are rare, but they’re more common for people who are self-employed than for employees.
Kristof is the editor of SideHusl.com, an independent site that reviews hundreds of money-making opportunities in the gig economy.