Self-Employed Need Apply: Tax Deductions That Pay Come Tax Time
According to a recent survey by the Boston College Department of Economics, the number of self-employed individuals rose last year by nearly 7 %, and there is ever indication that this number will continue to rise. With this trend comes a golden opportunity for IRS enrolled agents, CPAs and other tax professionals to tap new clients. There are scores of tax benefits associated with being self-employed that are forgotten each year by taxpayers who belong to this category. There are also various other applicable tax considerations-known to most any enrolled agent or registered tax agent -that should be communicated to these individuals come tax time.
A review of any tax CPE course on the subject of the tax advantages and implications of being self-employed is likely to turn up the following tips and suggestions.
Home Office Deduction
One of the biggest income tax deductions for self-employed taxpayers is the home office.
Tips for qualifying for the home office tax deduction include:
Home office qualifies for the tax deduction if it is the principal place of business, and is used regularly and exclusively for business. To pass the ‘place of business’ test, the home office must be the main place you where the business is conducted, or a place where the self-employed person routinely meet with client, or it must be a separate structure not attached to the home.
Regular and exclusive use means that the individual must spend at least 10-12 hours per week conducting business in the home office, and that the room is not used for other purposes.
A good example of a home office that qualifies for the tax deduction is a spare bedroom that is used exclusively as the base of operation. A bad example, and likely one ineligible for this deduction, is use of a dining room as a home office.
Qualifying Home Office Expenses
Expenses that are eligible for inclusion in the deduction include mortgage interest, real estate taxes, utilities, insurance, repairs, security, and depreciation. Deducting the business use of these expenses on the home office deduction schedule reduces business income, which in turn reduces self employment tax. This results in much greater tax savings than if a self-employed individual were to deducte these expenses on the itemized deduction schedule.
Business Use Percentage
However, only the business use percentage of these expenses can be deducted.?This percentage is calculated by dividing the square?footage of the office space by the square footage of the home, or by?dividing the number of rooms used for business by the number of?rooms in the house. Direct expenses-like repairs made to the space used for the home office, or telephones installed solely for business use-can be?deducted in full.
Indirect expenses-like mortgage interest and real estate taxes-should be allocated between the home office deduction and itemized?deductions, allowing the greatest tax benefit.
Home office tax deduction is calculated on Form 8829, Expenses for Business Use of Your Home.
Home office deduction limitations
There are two main limitations.
Deduction limited to profit: A business must earn a profit in order to qualify for the home office tax deduction. If expenses are greater?than business profits, the self-employed person must carry the excess expenses forward?to future years.
Depreciation recapture: In addition to mortgage interest, real estate?taxes and utilities, a deduction for the?depreciation of the home can be taken on the home office tax deduction schedule.?However, if the home is later sold, the?tax on any depreciation deducted on the home office schedule must be paid. This?is considered depreciation recapture, and it is taxed at the same rate as capital gains.
Other Notable Self-Employed Tax Deductions
Below is a list of other tax deductions that may benefit individuals self-employed.
Retirement Contributions-Contributions to a Solo 401k or other qualified plan are deductible on line 28.
Self Employment Tax-Half of the self employment tax piad can be deducted on line 27.
Contract Labor-Payments to independent contractors hire to complete work can be deducted.
Computers-The cost of computers used exclusively for work can be depreciate over multiple years or deducted it all at once using section 179.
Internet Access-Both at home and WI-FI access at Starbucks.
Website Expenses-Fees paid to buy domains, hosting, and other fees associated with running a website.
Cell Phone-While primary phone line cannot be deducted, a cell phone used for business is an eligible deduction
Advertising-Advertising costs are deductible.
Filing Fees-Fees paid to the state to maintain business licenses are deductible expenses.
Postage and P.O. Box Fees-To qualify, a separate P.O. box must be set up
Office Supplies-The cost of paper, pens, etc qualify as office supplies, and are deductible.
Mileage-Self-employed individuals are able to deduct business mileage on personal care, but need to keep good records.
Business meals-Business meals are deductible at a rate of 50%.
The deduction possibilities associated with being self-employed are seemingly endless, but, as with any unique employment arrangement, they need to be reviewed carefully by tax professionals who, because of their tax continuing education, understand how to best help this group get the most bang for the buck come tax time.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.