Tax Considerations

One of the transitions that many people must make when they begin working from home is understanding how they will be taxed on their incomes. Whether someone is working as an independent contractor or running a registered business, the tax structures are much different than being a traditional employee. While there are many deductions that can be taken to minimize the taxes owed, anyone doing work from home needs to take active steps in understanding how they will be taxed and how the Internal Revenue Service (IRS) views home business deductions. Here are some of the major tax considerations when working from home.

Stay Organized

The first, and most important, aspect of dealing with taxes when working from home is keeping your financial records organized at all times. As some of the following information will point out, the IRS requires very clear documentation for proving both sources of income and any deductions taken for business expenses. Depending on how much income is generated, there may also be a need to pay your taxes more frequently. Store all of your paper business records in a safe place and backup tax-related computer files to external disks or drives on a regular basis. Handling business records incorrectly will not only make it more difficult to file your taxes on time, but also possibly cost you a great deal of money in missed deductions or penalties levied by the IRS for improper filings.

Self-Employment Tax

Anyone who is self-employed is subject to the self-employment tax for all net incomes up to $106,800. This tax is the amount that you pay towards Social Security and Medicare. When employed by someone else where taxes are deducted, the employer normally pays half of these payments. When you are self-employed you must pay the entire amount. The self-employment tax is figured using using Schedule SE (Form 1040) with a current tax rate of 15.3 percent. The good news is that half of your self-employment tax can be deducted when calculating your adjusted gross income.

Estimated Tax Payments

The federal income tax system is structured on steady payments. In general, taxes are required to be paid on a quarterly basis rather than making a single payment at the time you file your tax return. Many people who work for an employer are not aware of this because the employer makes these quarterly payments for them. When you are self-employed, these estimated tax payments must be sent to the IRS by the 15th day of April, June, September and the following January. Normally, no estimated payments are required if you calculate that you will owe less than $1,000 in taxes for the entire year. How much you will have to pay each quarter is based on the amount of withholding and credits you would need to avoid making payments and the amount of withholding and credits you actually have. Some people choose to make voluntary quarterly estimated tax payments even if they do not owe anything in a particular quarter to avoid a large tax payment at the end of the year.

Home Office Deductions

One of the advantages of working from home is that your overall tax liability can be reduced through expenses you deduct for a home office. These expenses may include things like mortgage interest, utilities, repairs, insurance and depreciation. However, this is one area where the IRS has very specific requirements about what actually defines a home office and what percentage of home-related expenses can be taken as deductions. Generally, for home office deductions you must be able to prove that your home is your principle place of business, that you regularly use a portion of your home for conducting business and that your office space does not contain both business and general household activity. Because the percentage calculations for expenses are very specific and there are limits to home office deductions, it is best to refer to IRS publication 587 before filing a tax return.

Business Deductions

Any expenses related to your business activity can be used as deductions when calculating your adjusted gross income. The IRS defines business expenses as any costs that are necessary for conducting a trade or business. The expenses must be ones that are common to your type of business and helpful in your ability to complete your work. In other words, claiming a deduction for the expense of a lawn mower when your primary business is designing websites is not going to hold up in the event of an audit. While the types of business expenses you can deduct are extensive, they all must be well documented so it is essential that you can verify each one with a receipt or other proof of payment.