3 Tax Tips for the Self-Employed

With the job market in many areas as uncertain as the economy itself, more and more people are turning to self-employment. If you count yourself among them, here are three tips to consider:

1. Learn your liability. Self-employed individuals are liable for self-employment tax, which means they must pay both the employee and employer portions of FICA taxes. The good news is that you may deduct the employer portion of these taxes. Plus, you might be able to make significantly larger retirement contributions than you would as an employee.

You may, however, be required to make quarterly estimated tax payments, because income taxes aren’t withheld from your self-employment income as they are from wages. If you fail to fully make these payments, you could face an unexpectedly high tax bill and underpayment penalties.

2. Distinguish what’s deductible. Under IRS rules, deductible business expenses for the self-employed must be “ordinary” and “necessary.” Basically, these are costs that are commonly incurred by businesses similar to yours and readily justifiable as needed to run your operations.

The agency stipulates, “An expense does not have to be indispensable to be considered necessary.” But pushing this grey area too far can trigger an audit. Common examples of deductible business expenses for the self-employed include licenses, accounting fees, legal expenses, continuing business education, the costs of an Internet domain name and website hosting, and software that you’ll use for business purposes.

3. Don’t forget your home office! The tax code provides a tax deduction for many direct expenses (such as business-only phone and data lines, as well as office supplies) and indirect expenses (such as real estate taxes and maintenance) associated with your home office. The tax break is based on just how much of your home is used for business purposes, which you can generally determine by either measuring the square footage of your workspace as a percentage of the home’s total area or using a fraction based on the number of rooms.

The IRS typically looks at two questions to determine whether a taxpayer qualifies for the home office deduction: 1) Is the specific area of the home that’s used for business purposes used only for business purposes, not personal ones? 2) Is the space used regularly and continuously for business?

For example, if you also conduct business outside of your home, do client meetings or management or administrative functions typically take place in your home office? If you can answer in the affirmative to these questions, you’ll likely qualify for this helpful tax break.