UNDERSTANDING SELF EMPLOYMENT TAXES.
se Schedule C or C-EZ to report income?
Even if your self-employment income isn’t very much, you still have to report it to the Internal Revenue Service.
But depending upon your earnings and expenses, you may be able to file a much simpler form.
New role, new tax chores
When you own an unincorporated small business by yourself, the IRS considers you a sole proprietor. This means you have some extra tax-filing work to do.
Your business earnings (or losses) are included as part of your individual income tax filing. To determine just how much to report on your Form 1040 (and you must use the long form), you itemize your operational income and expenses on either Schedule C or Schedule C-EZ.
As the name indicates, the C-EZ is a streamlined version of the more-detailed Schedule C. So when can — and should — you use one form over the other?
Take heed of the title
Guidance comes from the form names. Schedule C is titled “Profit or Loss from Business.” The EZ is “Net Profit from Business.” If you report a business loss, you can’t use the short form.
The IRS also requires a Form C-EZ filer to operate only one business. If you run two or more sole proprietorships, you must file a Schedule C for each.
Schedule C-EZ also is acceptable if you:
- Have business expenses of $5,000 or less.
- Use the cash method of accounting.
- Do not have inventory at any time during the year.
- Never hire an employee.
- Do not depreciate any business property.
- Do not claim expenses for business use of your home.
- Do not carry over passive activity losses from an earlier tax year.
Don’t trade ease for savings
If you meet all of these requirements, then filing the simpler Schedule C-EZ probably will make your business tax life much easier.
But don’t opt for simplicity just to cut down on your tax-filing duties.
If your home office is indispensable to your firm’s operation, claim the deduction and use Schedule C. What it costs you in time to complete the longer form could more than repay you in tax savings. And it might not be that much more work now that the IRS has approved a simplified home office deduction method.
The IRS won’t penalize you for taking every legitimate business deduction you can. Don’t penalize yourself by using the wrong form.
Deducting your home office costs
Whether you are self-employed or an employee, if you use a portion of your home for business, you might be able to deduct the associated costs.
A home office deduction is generally easier for self-employed individuals to claim. But even then, the Internal Revenue Service has certain requirements a taxpayer must meet.
General requirements
First, your home office area must be used regularly and exclusively for your business needs.
Regular means just that. You can’t set up a computer in your den, sporadically type invoices and claim that room as your home office.
Exclusive is self-explanatory, too, but the IRS has provided some wiggle room here. The area of your home can be a room or other separately identifiable space. The space, says the IRS, does not need to be physically marked off from the rest of the room.
This change apparently was prompted by a tax court ruling a few years ago that allowed a work-from-home taxpayer to claim a deduction for proportionate use of some home space. But the exclusivity requirement is the same. Regardless of what specific space is your home office, you must use that room or area just for work.
A separate, detached structure such as a garage or guesthouse that is used regularly and exclusively for business also may qualify as a home office.
Second, the business part of your home must be either your principal place of business or where you meet or deal with patients, clients or customers in the normal course of your business.
A few years ago, the IRS also broadened the business activities that can be considered in determining whether a home office is a taxpayer’s principal place of business. Now, if a home office is used exclusively and regularly for the administrative or management activities of your business, it also qualifies.
Such things as billing operations, keeping your books and records, ordering supplies or setting up appointments qualify as administrative duties. Be careful here. The IRS cautions that your home location must be the only place where you can fulfill these responsibilities.
Possible break for employees, too
If you are an employee who also works at home, you must meet the same home office standards as do self-employed taxpayers. However, as an employee, your use of a home office to do your job must be for your employer’s convenience.
There are no hard-and-fast rules when determining whether your home’s business use is for your employer’s convenience. It depends on all the facts and circumstances.
A common case where this tax-deduction requirement applies, for example, is if your company does not provide you space at its location. However, having a home office simply because it makes things easier for you and your boss generally won’t pass IRS home office muster.
Where to claim home office costs
If you meet all the requirements to claim a home office, self-employed taxpayers have two options to claim the home office deduction. You can total your actual office expenses or use the simplified deduction method that took effect with the 2013 tax year.
Under the actual expenses method, some of the costs you can deduct include a portion of your real estate taxes, deductible mortgage interest, rent, utilities, insurance, depreciation, painting and repairs. The total amount you can deduct depends on the percentage of your home used for business. Your deduction will be limited if your income from your business is less than all your business expenses.
The simplified method allows you to deduct up to 300 square feet of your home office space at $5 per square foot for a total maximum deduction of $1,500. There are no record-keeping requirements or apportionment of your full residence’s other costs. Bankrate’s new tax tip about the simplified home office deduction offers more details.
If you use the actual expenses method, you figure your home office deduction on Form 8829 and transfer that amount to your Schedule C. Send in Form 8829 with your tax return. If you use the simplified home office deduction method, you’ll use the work sheet in the Schedule C instructions and enter the amount on Schedule C. No other forms are necessary.
Employees who claim a home office can use the work sheet found in IRS Publication 587, Business Use of Your Home, to calculate allowable expenses. The costs then are claimed as itemized deductions on Schedule A.
Selling your home and home office
While the home office deduction can help lower your tax bills, it does increase your tax-filing and compliance duties. And it could have some tax consequences when you sell your home. The largest tax factor here is depreciation claimed on the home office space for the years you used the actual expenses deduction method.
One home office issue, however, is no longer a tax problem when you sell your residence. Previously, when you claimed a home-based business deduction, you owed tax on that percentage of your home when you sold. A $100,000 profit on a home where 20 percent of the space was dedicated to business meant taxes due on $20,000.
In December 2002, however, the IRS decided that taxpayers no longer have to allocate gain between business and residential use if the business was conducted totally within the residence. So there’s no problem if your office is in your spare bedroom.
But if it’s in the guesthouse in your backyard, the portion of your sale proceeds attributable to that separate structure would be taxable, even though the building was part of your overall home sale. And you still must pay tax on the gain equal to the depreciation on the home office.
