10 Work-Related Tax Benefits

Whether you’re employed by a company or working as a freelancer/contractor, there are distinct advantages to each beyond just earning a wage. Freelancers, for instance, can capitalize on tax deductions for business expenses that employees may not qualify for. Conversely, employees often enjoy employer-paid benefits that can positively impact their tax liability. For employees, certain business expenses are deductible as miscellaneous expenses on Schedule A, albeit only if they exceed 2 percent of your adjusted gross income (AGI). This 2 percent threshold is relevant to the benefits outlined in this list.

If you’re weighing the choice between working as a contractor/freelancer or becoming a full-time employee, consider the following list. It can assist you in evaluating the tax implications of your decision.

Employees receive a valuable perk in the form of certain federal and state taxes paid by their employer with each paycheck. Although these deductions may not be visible to employees, they significantly benefit their financial standing. Without this contribution from employers, employees would be responsible for these taxes. Employment taxes cover:

  • Social Security and Medicare
  • Federal income tax withholding
  • Federal unemployment tax
  • State taxes

In contrast, freelancers, contractors, and other self-employed individuals are acutely aware of the impact of these taxes on their earnings because they must cover them themselves through the self-employment (SE) tax. The SE tax encompasses payments for Social Security and Medicare, which contribute to one’s coverage in the Social Security system.

The benefits of Social Security, and the necessity of contributing to it even as a self-employed individual, include retirement, disability, survivor, and hospital insurance (Medicare). For the year 2020, the SE tax rate stands at 15.3 percent, comprising 12.4 percent for Social Security and 2.9 percent for Medicare. Self-employed individuals can deduct the employer-equivalent portion when calculating their adjusted gross income (AGI) [source: IRS Self-Employed].

Many full-time employees, and even a fortunate few part-timers, enjoy the benefits of employer-paid or partially paid health, life, and disability insurance. If your employer provides such coverage, it’s essential to take full advantage of these programs. However, it’s crucial to assess whether these employer-sponsored plans offer adequate coverage for you and your family’s needs, considering your financial circumstances.

For freelancers, contractors, and individuals without access to employer-sponsored health plans, the Affordable Care Act mandates obtaining qualifying health insurance, known as minimum essential coverage, for yourself and your family. If you choose not to pursue insurance coverage, you have the option to apply for an exemption, subject to government approval.

Nevertheless, failing to obtain minimum essential coverage or secure an exemption may result in a penalty when filing your tax return. In the past, this penalty, known as the Individual Responsibility Payment, was typically the greater of 1 percent of household income or $95 per adult and $47.50 per child, capped at $285 per family. However, it’s important to note that these provisions were repealed by President Trump, eliminating the obligation to pay this fee if essential minimum coverage cannot be found.

Considering additional private life and disability insurance is also advisable, particularly if you are the primary income earner in your family. These types of insurance can provide vital protection for your family in the event of unforeseen circumstances that impact your ability to earn an income.

An exclusive benefit available to employees, not self-employed individuals, is a medical flexible spending account (FSA). With an FSA, you contribute funds throughout the year using pretax dollars. These funds can then be utilized for various medical expenses not covered by your health insurance, including deductibles, co-pays, eyeglasses, dental visits, and prescription medications.

Under the Affordable Care Act, the annual contribution limit for this account was reduced to $2,750. As the year draws to a close, it’s advisable to verify with your account administrator or review your account to ensure that all funds have been utilized. The U.S. Treasury has implemented changes allowing for the rollover of up to $500 to the following year, but this option requires your employer’s participation.

It’s important to consult your plan administrator for clarification. If your FSA operates on a use-it-or-lose-it basis and there are remaining funds at year-end, they may be forfeited, disappearing into a bureaucratic maze with no chance of recovery.

If your employer offers a 401(k) or a similar retirement savings plan, take advantage of it by contributing as much as you’re permitted and financially able, especially if your employer matches or adds to your contributions. Often, these contributions are made pre-tax, meaning the IRS won’t tax you on that portion of your income.

One key benefit of most plans is the ability to adjust your contribution amount at any time. As the calendar year draws to a close, consult your plan administrator to ensure you’ve maximized your contributions, and if not, consider increasing them if feasible. Contribution limits vary depending on the plan type and your age, so be sure to understand the rules specific to your plan.

For the self-employed, retirement savings options are also available. Consider opening an individual retirement account (IRA), which offers opportunities to save for retirement while providing tax advantages. IRAs come in two main types: traditional and Roth. With a traditional IRA, your contributions may be fully or partially deductible, and taxes are deferred until distribution. Conversely, Roth IRA contributions are not deductible, but qualified distributions are tax-free. Contribution limits for IRAs in 2020 were capped at $6,000 or the total of your annual income, whichever was lower. Individuals aged 50 and above were eligible to contribute up to $7,000 as a catch-up provision.

For the self-employed, deducting expenses related to a home office can be a significant advantage. If you’ve previously grappled with claiming this deduction, you’ll be pleased to learn about the simplified home office deduction introduced by the IRS in 2013.

To qualify for this simplified deduction, you must meet two basic criteria. Firstly, you must regularly and exclusively use a portion of your home for business purposes. For instance, converting the baby’s room into an office space wouldn’t qualify unless it’s solely dedicated to your business activities. Secondly, your home office must serve as your principal place of business.

Here’s how the simplified deduction works if you meet the above requirements:

  • You can claim a standard deduction of $5 per square foot of space used for business, with a maximum of 300 square feet (approximately 91 square meters).
  • You’re eligible to claim other allowable itemized deductions, such as mortgage interest, utilities, or real estate taxes, on Schedule A. However, the home depreciation deduction isn’t permitted with the simplified option.
  • If you prefer the intricacies of paperwork, you still have the option to calculate your home office deduction using the traditional method, which the IRS continues to allow.

If your home serves as your business headquarters, you can now opt for the simplified home office deduction, allowing you to deduct a portion of various expenses like mortgage payments, utilities, internet, phone bills, and equipment such as computers, printers, phones, faxes, and office supplies.

Additionally, if you use your car for business purposes, remember to consider auto expenses beyond just mileage, including insurance, gas, and maintenance. However, you typically can’t claim both mileage deductions and these additional expenses.

Be sure to familiarize yourself with the IRS guidelines regarding these deductions or consult with your accountant for advice. It’s worth noting that miscellaneous itemized deductions for employees are no longer applicable under current laws, so if you previously claimed them, be aware of the changes.

Employees have the opportunity to deduct unreimbursed travel expenses, encompassing travel between different workplaces or from home to another work site. For instance, if you primarily work remotely but occasionally need to travel to an office, these costs may be deductible. Similarly, expenses related to out-of-town trips, such as travel fares, meals, lodging, business calls, and laundry expenses, could also be deductible, either in full or in part. Moreover, expenses incurred for attending conventions or trade shows beneficial to your business may qualify for deductions.

For the self-employed, business travel expenses can typically be treated like any other business-related cost, with most, if not all, of the expenses deductible. It’s crucial to maintain meticulous records, however, as excessive deductions relative to your income might attract scrutiny from the IRS.

The IRS outlines criteria for deducting the expenses associated with work attire, which include the following:

  • You must wear them as a requirement of your job.
  • The clothing is not suitable for everyday wear [source: IRS Publication 529].

According to these guidelines, the attire must be distinctly job-related. For instance, painters mandated by their employers to wear all-white outfits may not claim the deduction, as white clothing could be worn regularly and outside of work. Certain professions eligible for the work-related clothing deduction encompass professional athletes, postal workers, law enforcement officers, firefighters, musicians, and theatrical workers. Furthermore, expenses for safety gear like shoes, boots, safety glasses, and hard hats might also qualify for deductions.

Typically, if you’re self-employed, all these costs can be deducted as part of your business expenses.

If you’ve pursued educational opportunities relevant to your profession this year, you might be eligible to deduct certain expenses, whether you’re an employee or a freelancer/contractor. The IRS has set specific guidelines regarding deductions for education: To qualify for deduction, education expenses must either “maintain or enhance your job skills” or be “required by your employer or by law to maintain your salary, status, or job” [source: IRS Educational].

However, there are a couple of exceptions. Education expenses aren’t deductible, even if they meet these criteria, if the education is “part of a program that qualifies you for a new trade or business or is necessary to meet the minimum educational requirements of your trade or business.” Deductible expenses may include tuition, books, supplies, lab fees, and similar items, as well as transportation and travel expenses.

When this article was initially drafted, certain job hunting expenses were eligible for tax deductions. However, regulations have shifted, and these expenses are no longer deductible. Initially, we planned to replace this segment with “Moving Expenses.” However, recent research indicates that most moving expenses are no longer deductible either, except for military personnel who had to relocate for work.

With a new presidential administration inaugurated on January 20, 2021, potential changes to tax laws in the forthcoming years remain uncertain. Regardless of the developments, we’ll ensure to keep you informed and updated!