Tax Guy: What are the best tax breaks for self-employed people?

More good news: Setting up a business office in your home can lead to additional tax savings.

Still more good news: You may also be able to claim the qualified business income (QBI) deduction.    

Here’s how self-employed folks can cash in on these three valuable federal income tax breaks. 

Note: By self-employed, I mean a sole proprietor, partner, or LLC member who is treated as a sole proprietor or partner for federal tax purposes. Onward.  

Step 1: Buy a suitably heavy machine

100% first-year bonus depreciation is available for eligible vehicles that are placed in service between now and 12/31/22. But this juicy write-off is only available for an SUV, pickup, or van that’s heavy enough. That means one with a manufacturer’s gross vehicle weight rating (GVWR) above 6,000 pounds that’s purchased (not leased) this year. 

So, you can write off 100% of the business-use portion of the cost of a suitably heavy vehicle on your 2022 business federal income tax return or form — as long as you use the vehicle over 50% for business this year. The vehicle can be new or pre-owned. 

If business usage is between 51% and 99%, you can deduct that percentage of the business-use portion of the cost in 2022. The write-off will reduce your federal income tax bill and self-employment tax bill, if applicable. You might also get a state tax income deduction. Nice.  

More than a few attractive vehicles have GVWRs above the magic 6,000-pound threshold. Examples include the Chevy Tahoe, Ford Explorer, Jeep Grand Cherokee, Porsche Cayenne, Toyota 4Runner, and many full-size pickups. You can usually find the GVWR on a label on the inside edge of the driver’s side door. Don’t expect dealer sales people to know which vehicles pass the over-6,000-pound-GVWR test. Check for yourself. Take nothing for granted.

If you buy a heavy vehicle next year, the first-year bonus depreciation percentage drops to 80% of the business-use portion of the cost. You can probably write off the rest of the business-use portion of the cost in 2023 thanks to the separate Section 179 first-year depreciation break. Your business-use percentage next year must exceed 50% for these write-offs to be available on your 2023 business tax return or form. 

First-year depreciation deductions for lighter passenger vehicles cannot exceed $19,200 for vehicles placed in service in 2022 and used over 50% for business. 

Step 2: Play the home office card

As stated earlier, the tax-saving first-year depreciation breaks are only allowed if you use your heavy SUV, pickup, or van over 50% for business. Calculate your business-use percentage for the year by dividing business mileage by total mileage. 

So far so good, but the over-50%-business-use test is sometimes difficult to pass. Thankfully, you’re much more likely to pass if you have an office in your home that qualifies as a deductible principal place of business. Then you can count all the commuting mileage from your home office to temporary work locations (such as client sites) as business mileage. Ditto for commuting mileage between your home office and any other regular place of business (such as another office you keep downtown).

Finally, you can also treat all mileage between any other regular place of business (such that downtown office) and temporary work locations as business mileage. These trips can add up to lots of business miles and make it much easier to pass the over-50%-business-use test.

More business mileage also means a bigger first-year depreciation deduction. For example, if you buy a $60,000 heavy SUV in 2022 and use it 80% for business, that translates into a first-year bonus depreciation deduction of $48,000 (100% x 80% x $60,000). If your business usage is only 60%, your first-year deduction drops to $36,000 (100% x 60% x $60,000). While that’s still pretty good, it’s not as good as a $48,000 write-off.

Finally, allowable home office expenses count as business deductions that will reduce your federal income tax bill and your self-employment and state income tax bills, if applicable.   

You have two different ways to qualify a home office as a principal place of business.  

First Way: Conduct most of your income-earning activities in the home office. 

Second Way: Conduct your administrative and management tasks in the home office. However to take advantage of this qualification rule, you cannot make substantial use of any other fixed location (like another office downtown) for administrative and management chores. 

Either way, you must use the home office space regularly and exclusively for business purposes during the whole year.  Exclusively means no personal use at any time during the year, so you might have to wait until next year to do what it takes to have a deductible home office and buy your heavy SUV, pickup, or van. No problem. That gives you more time to shop around for the right vehicle.

Step 3: Claim the QBI deduction

Through 2025, the qualified business income (QBI) deduction for self-employed folks can be up to 20% of: (1) QBI earned from a sole proprietorship or a single-member LLC (SMLLC) that’s treated as a sole proprietorship for federal income tax purposes plus (2) QBI from a partnership or an LLC that’s treated as a partnership for federal income tax purposes. So, if you have $200,000 of net self-employment income, as defined for QBI deduction purposes, you could have a QBI deduction of up to $40,000 on your Form 1040. Obviously, that would be a big tax-saver. For details on how the QBI deduction works and planning to maximize the deduction, see this previous Tax Guy column.

The bottom line 

You can potentially mate first-year bonus depreciation break for heavy vehicles with the home office deduction privilege and reap major tax savings from the combination. Then claim the QBI deduction for a tax-saving triple play. It’s baseball season, so don’t judge me! Speaking of judge, how about that Aaron Judge? Holy smokes! Yankee haters, please forgive.