Self Employed? Here's What You Need to Know for Tax Season
For self-employed workers, working from home offers more than just convenience. When using a home office for business use, you can qualify for several deductions, ranging from the home office deduction to expenses related to the business use of your car. To maximize your deductions, it’s important to make sure all of your expenses qualify for a write-off. If you’re uncertain, talk with a certified public accountant before filing your federal tax return.
- Tax deductions for the business use of your car
- Maintain good record-keeping
- The bottom line
Tax deductions for the business use of your home
As an independent contractor or freelancer, you may qualify to deduct home-related expenses on your tax return. To qualify, you must use part of your home regularly for your business. Building structures such as your garage, a barn, or an unattached studio also may qualify as an office space. In the alternative, you may claim your home office is the principal place of business or the location where you meet regularly with clients or customers.
Calculate your home office deduction
There are two ways to calculate your home office deduction. The first is the simplified square footage method. Currently, the IRS rate is $5 per square foot with a maximum of 300 square feet. For instance, if your office measures 200 square feet, your home office deduction would be $1,000.
If you want to be more exact, measure the exact square footage of your home office. What percentage is this amount of your total home square footage? For example, the total square footage of your home is 2,000 square feet. If your home office is 200 square feet, the home office is 10%.
Under the home office deduction, you would be able to deduct 10% of your home expenses such as mortgage interest, homeowners insurance, property taxes, depreciation, utilities, and general repairs that apply to the upkeep and running of your home. Expenses such as lawn care are excluded.
If you want to get the largest deduction available, you will need to calculate your home office deduction using both methods to see which one is greater.
Home office deduction limit
If your gross income is the same or more than your total business expenses, you should be able to deduct the entirety of your business expenses for the business use of your home. However, if your gross business income is less than those expenses, there is a limit to what you can deduct based on your expenses. It’s best to consult with an accountant to determine your deduction.
Tax deductions for the business use of your car
If you use your car to conduct business, you can deduct car-related expenses; how much, though, depends on how much you use the car for work. If your vehicle is used exclusively in your business, you can deduct the total amount of car-related expenses. However, if you use your car for both personal and business use, you have to divide your expenses based on the actual mileage used for each category. Qualifying expenses include:
- Business miles
- Gas and oil
- Registration fees
- Depreciation or lease payments
If you don’t want to figure the business part of these expenses, you may be able to determine your deduction using the standard mileage rate. For 2020, the standard mileage rate is 57.5 cents per mile. Even if you use the standard mileage rate, if you are self-employed you still may be able to deduct the business part of the interest on your car loan, any state and/or local personal property tax on the car, tolls, and parking fees.
To determine which method benefits you the most, calculate your deduction using each method.
Other business expenses that may qualify for tax deductions
There are many other business-related expenses that also may be deducted on your income tax return. The rule of thumb is, if the expense is “ordinary and necessary” in your day-to-day course of business, then it should qualify as a tax deduction.
Equipment and office supplies
The items you routinely use in your day-to-day business operations typically can be deducted for their full value. Examples include:
- Pens and pencils
- Printer ink cartridges
- File folders
You also can deduct the cost for larger purchases such as computers, printers or other special equipment, but it’s possible you may need to depreciate the value over time. If you are unsure how to list the deduction on your tax return, talk with an accountant.
If you eat out for a business-related meal, the cost most likely can be deducted. If the meal is deemed “lavish or extravagant” or combined with entertainment, then it may not qualify. Until 2021, the amount of your deduction would be 50% of the cost of the meal. For 2021, you can deduct 100% of the meal. This is a temporary change that will expire at the end of 2022.
When you travel for business, you can deduct the cost of flights, hotels, car rentals, taxis, and food (see “meals” above) while on the road. However, you cannot deduct any travel expenses for anyone other than yourself unless it’s for an employee.
If you have an accountant, attorney, or consultant who you work with routinely for your business needs, these expenses are deductible.
Surprisingly, you can actually deduct one-half of your self-employment tax on your income taxes. It’s important to note that if you operate under a limited liability company (LLC) or C corporation, this tax situation will be different for you.
Interest on loans and credit cards
If you have business loans or maintain balances on a credit card for business purposes, you can deduct the interest on your tax return. You are not required to have a business credit card to qualify for this deduction, although that does simplify the process. If you have a personal card that you use exclusively for business expenses, it, too, will qualify for this deduction.
If you just started your business, there are numerous startup costs you can deduct on your tax return. These include equipment, basic supplies, advertising, professional fees, and other expenses. The maximum deduction is $5,000 provided your costs are $50,000 or less. If your expenses are more than $50,000, you have to reduce your first-year deduction by the amount that is greater than $50,000. If those expenses are more than $55,000, you cannot claim the startup deduction. Instead, starting your second year in business, you will need to amortize your expenses and deduct them over the next 15 years in equal installments.
If you purchased health, dental, or qualifying long-term care insurance for yourself or your family, it’s possible you may qualify for a self-employment tax deduction for the health insurance premiums. Rather than an itemized deduction, this is treated as an adjustment to your income. If you’re not sure, talk to an accountant to see if you qualify.
As you save for retirement, your contributions to qualifying retirement plans may be tax-deductible. How much depends on which account you choose, such as an IRA or 401k.
Miscellaneous itemized deductions
Expenses such as advertising (for example, business cards, a website or billboards), professional association members, business conferences, business insurance premiums, and continuing education courses also may be qualifying deductions.
In addition, if you have subscriptions to specialized publications and books directly related to your business, those would be qualified tax deductions. For example, if a journalist has an online subscription to the Associated Press Stylebook, that would qualify.
Your cell phone can qualify for deductions of you use it for work. Again, a certified public accountant (CPA) can breakdown your expenses based on personal and business use.
Qualified business income deduction
A relatively new deduction for self-employed and small-business owners, the qualified business income deduction is a deduction for a portion of your business income. To qualify, you will need to file as a sole proprietorship, partnership, S corporation, or LLC.
The deduction looks at your entire income, not just your business income. If your total taxable income is equal to or less than $163,300 for individuals or $326,600 for joint filers, then, for 2020, you may qualify for the 20% deduction. For 2021, the limits increase to $164,900 for individuals and $329,800 for joint filers.
Maintain good record-keeping
It’s important to maintain good records of your business and home-related expenses. Not only does this help when preparing your tax return, but it also will be necessary in the event of an IRS audit. Records you should keep include:
- Receipts for business supplies and equipment
- Copies of your mortgage interest paid during the tax year
- Property tax bills and receipts for payment of said taxes
- Utility bills
- Homeowners insurance bill
- If you rent, a copy of your lease
- Receipts for all other expenses you plan to deduct for business purposes
- Business bank account statements
When filing your tax return, sole proprietors will report work-related expenses on a Schedule C, which will be filed with their Form 1040. If you have an LLC and you are the only employee, you may file with a Schedule C, E or F; however, if you want to file as a corporation, you will need to file either a Form 8832 or 1120S. Those with an S Corp must file a Form 1120S with a Schedule K-1.
Knowing which tax deductions you can take when working from home can be very confusing. Here are some of the common questions taxpayers have regarding tax deductions if they worked from home.
Can I take the home office deduction?
As long as you prove you use a dedicated portion of your home for regular business use, you should be able to take the home office deduction.
Can I deduct car expenses as a business expense?
Just as with the home office deduction, you must show that you use your car for business use. If your vehicle is exclusively for business, then, yes, you can deduct qualifying car expenses. However, if your car is used for both business and personal use, you will need to determine how much of your mileage and expenses are for business in order to deduct them.
Is it necessary to document every business expense when working from home?
The short answer is yes. It’s important to keep good records in order to support your tax returns in the event of a tax audit. The long answer is also yes. If you want to maximize your tax deductions, you need to document every expense.
Are my tax deductions the same every year I work from home?
No. Not only will your tax deductions vary from year to year based on your actual expenses, but they also will vary based on changes to specific deductions by the IRS. For instance, the standard mileage rate changes often, which will affect your tax deductions.
The bottom line
As a self-employed worker or small-business owner working from home, there are numerous tax deductions you can take on your federal income tax return. These range from the home office deduction to deductions for office supplies, meals and travel, and contributions to retirement savings. There may be additional tax deductions available to you, so it’s important to research the issue or talk with an accountant.
To receive your tax deductions for working from home, you will need to file the appropriate tax forms by the filing deadline each year. If you are unsure what tax deductions you can take, consult with an accountant to find out which ones apply to your business.