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Are you considering joining the Great Resignation and becoming self-employed to be in charge of yourself?

Yes?  Okay, but before leaping, consider the tax implications. This self-employment thing may not be as rosy as it appears.  Here’s the big picture.

Despite what some may believe, becoming self-employed won’t allow you to
write off all your meals as a business expense, deduct the cost of taking your friends to sporting events, deduct all your transportation expenses, and write off the entire cost of owning or renting a residence that contains your home office.  Sorry about that.  While there are some tax advantages to being self-employed, they are underwhelming and should not be the main reason for deciding to go out on your own. We cover tax benefits later in this analysis.
The big non-tax disadvantage is you’ll have to pay for things that were formerly provided by your employer, such as health insurance, retirement plan contributions, a company car, company-paid business trips that included elements of pleasure, meals when you worked late at the office, and
so forth.  And there is one big tax disadvantage: the dreaded self-employment tax.  Now, some details on the tax issues most likely to affect you as a self-employed taxpayer.

The self-employment tax is how our beloved U.S. Treasury collects Social Security and Medicare taxes on non wage income from business-related activities. For 2022, the self-employment tax rate is 15.3 percent on the first
$147,000 of net self-employment income.  That 15.3 percent rate is comprised of: 12.4 percent for the Social Security tax component of the self-employment tax plus 2.9 percent for the Medicare tax component.  Above the $147,000 threshold, the Social Security tax component goes away, but the 2.9 percent Medicare tax continues before rising to 3.8 percent at higher self-employment income levels. The 3.8 percent rate consists of the “regular” 2.9 percent Medicare tax plus the 0.9 percent additional Medicare tax on higher earners.

If you make good money, the self-employment tax can be a big number. You’ll need to include what you owe for self-employment tax with your quarterly estimated federal income tax payments to avoid an IRS underpayment penalty.

Every year, the Social Security tax ceiling goes up based on an inflation adjustment. In turn, it’s likely your self employment tax bill will go up.  Last August, before inflation kicked in, the Social Security Administration issued its latest projected ceilings for future years.
$156,000 for 2023
$162,900 for 2024
$168,600 for 2025
$173,300 for 2026
$180,600 for 2027
Ugh! The projected numbers are bad enough, but they don’t reflect the current rate of inflation. You have to bet that actual upcoming ceilings will be higher, perhaps much higher.

One proposed tax-law change that has been floated would restart the 12.4 percent Social Security tax on net self-employment income above $400,000. This is the so-called donut hole approach to increasing the Social Security tax.

You can write off half of the 12.4 percent Social Security tax component of the self-employment tax and half of the 2.9 percent Medicare tax component. You don’t need to itemize to claim this deduction.  But you can’t deduct any part of the additional 0.9 percent Medicare tax that’s imposed at higher levels of net self employment income.

If you’re willing to go to some trouble to potentially minimize the self-employment tax bite, consider operating your new shop as an S corporation.

For the 2022 tax year, a self-employed individual can potentially make a deductible contribution of up to $61,000 to a tax-favored retirement plan. Maybe more if you set up a defined benefit pension plan.  Available plan options include a simplified employee pension (SEP), a Keogh profit-sharing plan, a solo 401(k) plan, a SIMPLE-IRA, and a defined benefit pension plan.

You can probably claim an above-the-line deduction for health insurance premiums, including Medicare, if you are self-employed as a sole proprietor,
an LLC member treated as a sole proprietor for tax purposes, a partner in a partnership, an LLC member treated as a partner for tax purposes, or an S corporation shareholder-employee.  But you can’t claim this write-off if you’re eligible for other subsidized health insurance, such as under your spouse’s employer-sponsored plan.

For 2022, you can deduct 100 percent of the cost of business meals provided by restaurants. After this year, the deductible percentage will fall back to 50 percent unless Congress extends the 100 percent deal. We doubt that will
happen, but you never know.

Thanks to the Tax Cuts and Jobs Act, you can claim 100 percent first-year bonus depreciation for heavy SUVs, pickups, and vans that are purchased (not leased) and placed in service between September 28, 2017, and December 31, 2022, and used over 50 percent for business.3
Both new and used vehicles can qualify.

Heavy SUVs, pickups, and vans are exempt from the luxury auto depreciation limits because the tax code treats them as transportation equipment rather than passenger vehicles. Therefore, these heavy vehicles are eligible for first-year bonus depreciation, including 100 percent bonus depreciation when available.  But since the tax code classifies these vehicles as listed property, you must use that heavy vehicle over 50 percent for business to qualify for juicy first year depreciation write-offs.  With 50 percent or less business use, you depreciate the business-use percentage of the heavy vehicle’s business
cost using the straight-line method—where it will take six tax years to fully depreciate the cost.

First-year bonus depreciation is available only when the SUV, pickup, or van has a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds.  Popular examples of heavy vehicles include some models of the Buick Enclave, Ford Explorer, Chevy Suburban, Jeep Grand Cherokee, and lots of full-size pickups.

If you become self-employed, you could set up the right type of deductible office in your home and gain a big head start toward meeting the over-50 percent-business-use requirement for claiming a big first-year depreciation
deduction for a heavy SUV, pickup, or van.  The home-office deduction is allowed if you use part of your residence during the tax year regularly and exclusively as: (1) a principal place of business or (2) a place to meet with customers or clients. For a separate structure such as a converted barn, pool house or detached garage, deductions are allowed if you simply use the space regularly and exclusively for any business purpose.  Expenses directly allocable to your home office space, such as repair and maintenance costs, are fully deductible.  You can also deduct indirect home office expenses—such as utilities, property taxes, casualty insurance premiums, homeowner association fees, security monitoring, depreciation for a residence you own, rent for a rented residence, and so forth. A percentage of these expenses can be allocated to the home office space based on square footage or the number of rooms in the residence.

A home office qualifies as your principal place of business if most of your income-earning activities occur there.  It can also be your principal place of business if you use it to conduct administrative or management functions and don’t conduct those functions at any other fixed location.  If you have a home office that qualifies as a principal place of business, your commuting miles from home to various temporary work locations count as business mileage.
Ditto for commuting mileage from your home to any regular place of business, such as an “official” office in town.  Finally, you can treat all the mileage between the “official” office in town and various temporary work locations as business mileage.  When your home office meets the definition of a principal place of business, it’s usually pretty easy to rack up lots of business mileage, making it much easier to clear the over-50 percent business-use hurdle and thereby qualify for the generous first-year vehicle depreciation write-offs.

The qualified business income deduction was a centerpiece of the TCJA. For 2018-2025, the QBI deduction is available to eligible individuals.  The QBI deduction can be up to 20 percent of: QBI earned from a sole proprietorship or single-member LLC that’s treated as a sole proprietorship for federal tax purposes, plus QBI passed through to you from a pass-through business entity—meaning a partnership, LLC classified as a partnership for federal tax purposes, or an S corporation.  Pass-through business entities report their tax items to their owners who then take them into account on their owner-level returns.  The QBI deduction, when allowed, is then written off at the owner level on IRS Form 1040.[/vc_column_text][us_image image=”3648″][/vc_column][/vc_row]