Written by Charles Renwick. Published by Quicken on September 20, 2022.
Another year-end is approaching and it’s time to start thinking about taxes.
“But I get a W-2. There’s nothing I can do for tax planning!”
I hear this a lot. It is true, the options available to W-2 employees are more limited than the options available to small business owners. But that doesn’t mean you don’t have options. Let’s take a look at the problem, review some common expenses you need to deduct, and consider ways to save money on taxes this year.
Maximizing your refund as a W-2 employee
The W-2 problem in tax planning
The Tax Cuts and Jobs Act of 2017 made significant changes to how individuals are taxed. Perhaps the most impactful changes were the revisions to the individual deduction rules. Specifically, the standard deduction was doubled, and previously allowed deductions like unreimbursed business expenses for W-2 employees were limited or eliminated.
While this “simplified” tax reporting for thousands of Americans, it also created a situation that does not seem fair because now, only small business owners can take advantage of the most popular deductions.
Popular deductions that W-2 employees can’t claim
- Home office: As a W-2 employee in the cloud-computing, post-COVID-19 era, you probably sometimes work from home. You might think that you can deduct your home office expenses. Sorry, you can’t.
- Cell phone: You likely use your cell phone for work all the time, right? If you’re like most people, your cell phone is used for business calls and emails more than it is for personal calls and emails. But can you get a tax deduction if you pay for your cell phone bill yourself? Nope.
- Mileage/vehicle: Gas is expensive and you go the “extra mile” to get the job done for the company. The company budgets are tight and your boss can only reimburse a fraction of your actual costs of ownership. But at least you get a tax deduction, right? Wrong again.
So if you have all these business expenses but you can’t deduct them because you’re not a small business owner, what can you do? Become a small business owner! It’s actually easier than you think. The two best ways to become a small business owner are:
- Buy and manage rental properties, or
- Work a side gig that pays a 1099
When you have rental properties or a side gig that pays a 1099, you open up opportunities to deduct lots of your expenses that you can’t deduct as a W-2 employee. The particular rules for each deduction are important and I am not suggesting you claim deductions unrelated to your new small business. But overlapping expenses that are necessary for your new small business are fair game, and you are entitled to deduct at least a portion of these expenses that would otherwise not be deductible.
Using business deductions to maximize your refund
Rental property or 1099 tax planning: the basics
At a high level, rental property operations and 1099 side gigs are considered business. Therefore, they get to take business deductions. What qualifies as a business deduction is very much based on the business purpose and facts and circumstances, but in general, there are lots of expenses that qualify that you would not otherwise be able to deduct.
Popular rental property or 1099 tax deductions
Again, the business purpose and your specific facts and circumstances are the main considerations when looking for deductions, but here is a list of popular deductions to give you an idea of the kinds of things you should be tracking because they are usually deductible.
- Internet Expenses
- Business Meals
- Business Travel Expenses
- Advertising Expenses
- Supplies Expenses
- Insurance Expenses
- Repairs and Maintenance
- Professional Services
- Rent Expenses
- Utilities Expenses
Other things to consider
Your tax deduction increases your return on investment (ROI)
Rental property investments and side gigs are already a great economic opportunity for growing wealth. But the additional tax benefits you gain make these opportunities even more compelling. For example consider this scenario:
- You pay a marginal 25% income tax rate
- You make an extra $5,000 working a side gig
- This side gig allows you to access $5,000 in deductions you previously were not able to access
What’s the economic result? You effectively increase your side gig income by 33%. Why? Because without the deductions, you would have had to make $6,666 in income to keep that $5,000 after taxes. In other words, your deductions allow you to earn that $5,000 tax free.
Does this mean you’ll get a big tax refund? Not necessarily. That depends on the rest of your financial picture including how much you paid in taxes during the year and how much you owe overall. But those business deductions are reducing your total tax obligation. Whether you get a bigger refund or you just pay less, you win either way.
Keep clean records and receipts
Documentation is always important when it comes to ensuring you have minimal risk if audited, and you need to keep your records and receipts for three years. Using accounting software like Quicken keeps you organized and ensures you don’t miss any deductions.
Use a CPA
This is a general disclaimer but also some good advice. As you can see from the example above, a small side gig has significant tax consequences. In fact, the amount of money at stake is far greater than the nominal cost of using a CPA. Because everyone’s situation is different and the facts and circumstances matter, a CPA can make sure everything is done correctly. Plus, a CPA might identify additional tax savings opportunities.
So what are you waiting for? Year-end is approaching — start planning now!