Self‑employed individuals may claim several adjustments to income on Schedule 1 (Form 1040). These adjustments reduce AGI and are available to sole proprietors, independent contractors, partners, and certain S corporation shareholders.
Deductible Part of Self‑Employment Tax
A taxpayer who carries on a trade or business as a sole proprietor or independent contractor is considered self‑employed. Partners also have self‑employment income through their distributive share of partnership earnings.
Self‑employment tax is computed on Schedule SE, and 50% of the self‑employment tax is deductible as an adjustment to income.
- Deduction is taken on Schedule 1
- Applies only to the employer‑equivalent portion of SE tax
- Does not reduce net earnings for SE tax purposes
Self‑Employed Health Insurance Deduction
Taxpayers use Form 7206 to compute the self‑employed health insurance deduction.
They may deduct premiums paid for:
- Medical insurance
- Dental insurance
- Qualified long‑term care insurance (subject to limits)
- Coverage for spouse, dependents, and children under age 27 (even if not dependents)
Who Qualifies
One of the following must apply:
- Net profit on Schedule C or Schedule F
- Partnership income reported on Schedule K‑1, box 14, code A
- Net earnings computed using optional SE methods
- More‑than‑2% S corporation shareholder with premiums included in wages
Plan Must Be “Established Under the Business”
Rules differ by entity type:
- Sole proprietors: policy may be in business or individual name
- Partners: partnership must pay or reimburse premiums and report them as guaranteed payments
- S corporation shareholders: corporation must pay or reimburse premiums and include them in Form W‑2, box 1
If reimbursement is not made, the plan is not considered established under the business.
Limitations
- No deduction for any month the taxpayer is eligible for subsidized employer coverage (their own or spouse’s)
- Deduction must be subtracted from medical expenses on Schedule A if itemizing
Self‑Employed Retirement Plan Contributions
Self‑employed taxpayers may deduct contributions (other than Roth) to:
- SEP plans
- SIMPLE plans
- Qualified plans (profit‑sharing, money purchase, defined benefit, 401(k))
These deductions are taken on Schedule 1.
SEP Plans
A SEP plan allows contributions to a SEP‑IRA.
Contribution limit for 2025:
- 25% of net earnings from self‑employment, or
- $70,000, whichever is less
Contributions must be made in cash.
Defined Contribution Plans
Contribution limit for 2025:
- 100% of net earnings, or
- $70,000 (plus catch‑up contributions)
Catch‑Up Contributions (2025)
- Age 50+: $7,500
- Age 60–63: $11,250 (SECURE 2.0 “higher catch‑up”)
SIMPLE Plans
Two types:
- SIMPLE IRA
- SIMPLE 401(k)
Contribution limit for 2025:
- $16,500
- Age 50+ catch‑up: $3,500
- Age 60–63 “higher catch‑up”: $5,250
Compensation for Self‑Employed Plan Contributions
Self‑employed taxpayers must compute “compensation” using net earnings from self‑employment, reduced by:
- Employer‑equivalent portion of SE tax (7.65%)
- Their own retirement plan contribution
Because the deduction and net earnings depend on each other, the contribution rate must be adjusted:
Example (Rewritten)
A taxpayer has:
- $100,000 net income
- $7,650 employer‑equivalent SE tax
- SEP plan rate: 25%
Adjusted rate:
Contribution:
$92,350 * 0.20 = $18,470
Compensation after contribution:
$92,350 – $18,470 = $73,880
Net Earnings From Self‑Employment
Includes:
- Sole proprietor net income
- Partner’s distributive share of partnership income
- Guaranteed payments to partners for services
Does not include:
- S corporation shareholder distributions
- Limited partner distributive share (unless for services)
- Items excluded from gross income (except foreign earned income and foreign housing amounts)