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Major life milestones often have a major tax impact. Changes in your marital status, having a baby or adopting a child can have significant impact on your taxes. This is the place to ask questions about dependents, real estate, and other various scenarios that play a significant role in what taxes you pay.

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Pioneer
Posts: 2
Registered: ‎09-11-2017

First Year Self Employed: Deductions/Credits & Refunds

Hello Everyone,

 

My fiancee was self-employed for the first time this year. He will make about $30k in income and have roughly $12k in deductions (mileage, cell phone, insurance...) He does not own a home, does not have children, does not have a retirement plan yet and is not a student. 

 

From what other, more experienced, people in his field are telling him, he is thinking he may receive a refund this year. They have filled his head with tales of $4k-$6k refunds. I am thinking not so much, since from what I understand mileage (the largest chunk of his deductions), is just a deduction to offset his tax due and is not refundable. If I understand correctly, most of those items are like that.

 

Am I correct in thinking he likely is not going to receive much of a refund since he doesn't seem to qualify for any refundable credits? 

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Trusted Council Member
Posts: 6,191
Registered: ‎02-23-2016

Re: First Year Self Employed: Deductions/Credits & Refunds

Hi stephaniemarie,

 

 

Welcome to the H&R Block community.

 

I've got some important information for you on this.  Not only is your fiancée not going to get a refund, he will owe a considerable amount of tax and should begin making estimated tax payments to the IRS immediately.

 

Note that taxes normally are not withheld for the self-employed, but if he was paid on a 1099-MISC or if he owns his own business and made some estimated tax payments during the year then he may not owe as much or may get a small refund.  Withholdings and payments made during the year reduce the tax due with your tax return.

 

Let's go into more detail with this now so that you can kind of picture how self-employment works.  After that I'll figure out how much tax he actually will owe for you based on the information you've provided and I'll explain the estimated payments part of this.

 

Self-employment income is reported on Schedule C and then expenses are deducted from it.  Your fiancé will only be taxed on his net income (income after expenses have been deducted), so it's very important that he deduct every expense he possibly can.  For example, if he brought in $40,000 but he had $25,000 worth of expenses then your fiancé would only be taxed on his net income of $15,000.

 

The mileage deduction is a great deduction.  It adds up quickly if you drive a lot.  The mileage rate is 53.5 cents per mile for 2017, so if, for instance, your fiancé drove $10,000 miles for business purposes that's in excess of a $5,000 deduction.  Things like work clothes, work phone usage, and supplies are also deductible.  Home office expenses are deductible if he has a qualifying home office.  There is also a depreciation deduction for the cost of things like furniture & equipment.  If he has a resale inventory then he will have a cost of goods sold deduction.

 

The self-employed must pay the following taxes:

  • federal income tax
  • Social Security tax of 12.4%
  • Medicare tax of 2.9%

Your fiancé will get a deduction on the 1040 for 1/2 of the social security & Medicare taxes.

 

So how do we reduce the taxes other than by deducting expenses against self-employment income on Schedule C?  The biggest possible way to reduce these taxes is with tax credits.  Note that the FICA taxes can be reduced only with refundable tax credits.  The second way to reduce the three federal taxes is with excess withholdings from another job.

 

So now let's go through your actual situation and figure out how much tax your fiancé will owe or if a refund might be possible.

 

 

SOCIAL SECURITY TAX  =  3,435.42

This is figured by multiplying 92.35% of your $30,000 worth of self-employment income by 12.4%.

 

MEDICARE TAX  =  $803.45

This is figured by multiplying 92.35% of your $30,000 worth of self-employment income by 2.9%.

 

SELF-EMPLOYMENT TAX DEDUCTION  =  2,119.44

This is figured by first adding together your social security & Medicare taxes.  Then we divide that figure by 2.

 

FEDERAL INCOME TAX (15% BRACKET)  =  2,169.33

This is figured by first subtracting your self-employment deduction from your gross income to arrive at an AGI of 27,880.56.  The second step is to subtract the standard deduction amount of $6,350 and a the personal exemption amount of $4,050 from your fiancé's AGI which gives us $17,480.56 for his taxable income.  Finally, we multiply income in excess of $9,235 by 15% and add $932.50 to that amount.

 

TOTAL TAXES  =  $6,408.20

 

 

The total estimated taxes amount that I just figured for you will be lower if you fiancé has more expenses to deduct.  In addition to all of the items that I mentioned previously health insurance premiums that are paid for our of pocket can be deducted directly on the 1040.

 

The next question is whether or not your fiancé will qualify for any tax credits.  Because he does not have any dependents he will not qualify for any of the child-related credits.  If he has marketplace health insurance he might get some premium tax credit.  He also does not own a home and does not have a retirement account based on the information you provided so that will rule out most of the remaining credits.

 

So let's look at estimated tax payments and then I'll give you a couple of ideas on how he can further reduce his tax liability.

 

Estimated payments must be made four times per year if you expect to owe $1,000 or more.  Your fiancée should be paying 1/4 of 90% of his estimated tax liability each April 15th, June 15th, September 15th, and January 15th.  For 2017 however if you live in Florida or any other area that was declared a hurricane disaster area then you have until January 31st to make the September and January payments.  Your fiancé's payments should be at least $1,441.85 each quarter based on the income figure you gave me.

 

There is some good news though.  If your fiancé did not owe any tax for the 2016 tax year then he does not have to make estimated payments for 2017 because he will qualify for an exemption from the estimated payments rule.  Going forward though there will be penalties and interest assessed by the IRS if payments aren't made and he doesn't qualify for an exemption.

 

So lastly I have some advice on further lowering your tax liability.  You mentioned that your fiancé does not have a retirement account.  I suggest starting one.  If your fiancé were to start a traditional IRA (individual retirement account) he could contribute $5,500 at maximum and that would reduce his taxable income for the federal income tax by $5,500.  Contributions to a traditional IRA are tax-free until the money is withdrawn later on at retirement.  You can make an IRA contribution for 2017 until April 17th, 2018, so you still have plenty of time.

 

Another way to reduce tax liability is to start a health savings account.  If he doesn't have health insurance, your fiancé could opt to purchase a high-deductible health plan.  In some situations this type of plan counts as minimum essential coverage under the ACA.  Once he has a high deductible health plan he could then open an HSA account to go with it.  Contributions to an HSA account are not taxable in the year you make them, and the funds remain tax-free forever if you spend them on medical expenses.  Also, if you become eligible to contribute to an HSA in December then you're treated as having been eligible for the entire year so long as you remain eligible for the next 12 months following the December in which you became eligible.  Up to $3,300 can be contributed to an HSA by an individual, so that's another $3,300 reduction taxable income for the federal income tax.

 

One more idea is that if your fiancé covers your expenses he might be able to claim you as a qualifying relative.  We would have to look at the qualifying relative rules and answer some questions, but if you were to qualify that would reduce taxable income for the federal income tax by another $4,050.

 

 

If you have any other questions I'll be glad to help.

 

Louis,

Senior Tax Advisor (Tampa, FL)