15 Home Business Tax Questions Answered

Simple Answers For Tough Self-Employment Tax Quesitons

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Many would-be home based business owners or freelancers hesitate to get starting in their self-employment journey because they're concerned about the tax issues. They think it's complicated or worry about the ramifications of making a mistake. While self-employed taxes require a little bit more work, they offer enough benefits to make learning about it worth the effort. Here are answers to the top 15 questions related to self-employment taxes.

1) Should I take the home office deduction?

There was a time when writing off a portion of your home for business purposes would increase your audit risk. With over 50 percent of businesses run from a home office, that is no longer the case, so don't be afraid to take the home office deduction. Just remember that you can only write off the space that you use exclusively and regularly for your business. Learn more about the home office deduction.

2) Can I write-off my car as a business expense?

Any expense you have that is required for you to do business can be a business tax deduction, that includes travel business expense. You can right off the portion of your vehicle used for business purposes. To take the write-off, you must prove business use of the car through organized record keeping. You're given two options to take the business car deduction, the easiest of which is to track your mileage using a logbook or a business app.

Each year, the IRS gives a mileage rate. Simply multiply the rate by the business-related mileage you tracked to get your deduction. The second option is to use actual expenses. For that you'll need to keep all records related to the care and maintenance of your car. 

3) What type of deductions can I take for being self-employed?

Two of the perks of self-employment are 1) receiving your gross income and 2) work-related tax deductions.

This can make tax time a little more complex, because you have to pay self-employment taxes and social security your employer usually deducts for you. But unlike in a traditional job, you can deduct many expenses that you can't in a job. For example, you can't deduct your commuting expenses in a job, whereas you can deduct business-related travel. Nearly any expense that is necessary to run your business is deductible, include your Internet access, marketing costs, and more. Here are 15 common self-employed tax deductions.

4) How many years can I go without earning a profit on my home business?

The IRS understands that sometimes businesses, especially startups or during economic hardship, might have a loss. There are several aspects of a business that the IRS considers in deciding if you have a business or a hobby.The most important factors are whether or not you're operating like a business, such as creating a business structure, you have an intention of making a profit, you engage in activities to build your business, and more. If you're behaving like a business, then the IRS is more likely to view you has one. If you have a  net loss in more than two out of the five years in operation, you run the risk of being considered a hobby business.So in essence, you want a net profit in at least three out of five years.

 Continual business losses (meaning you write-off more than you make), leaves you are at higher risk of receiving an IRS audit. With that said, you can write off your hobby-business expenses up to the amount you earn. If you earned $1000 but had $1,500 in expenses from your hobby business, you can deduct $1,000. However, if you meet the requirement of a business, you could deduct $1,500 and take the $500 loss. Visit the IRS for information on a business vs hobby.

5) Do I need receipts for all my write-offs?

Yes. Keeping receipts for all expenses and deductions is important because the burden of proof rests with you if audited. There are a variety of filing systems you can use to wrangle all your receipts in order. You may want to use a business accounting software to help you organize your income and expenses, and to make generating tax reports easier.

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6) How much self-employment income can I receive without having to report it?

None. The IRS requires you to report ALL of your income. Depending on the type of home business you have, you might receive a 1099-MISC form.However, if you sell your products or services directly, you may not receive any sort of income statement. But that doesn't mean you don't have to report what you've earned. It's important to keep track of all income you receive from your business and report it all.

7) Should I hire an accountant to help me with my home business taxes?

Not necessarily. It is up to you to decide whether or not to seek outside help as you prepare your personal and business taxes. If you have little experience preparing your business taxes, it may be a wise investment to seek out help for the first year or two. Financial management and tax software can be helpful if you don't have the budget for an accountant or tax professional. Note that business accounting and tax services are tax deductible.

8) What are the top audit flags for a home business?

You shouldn't let the fear of an audit prevent you from starting a home business. However, you should let the fear of an audit encourage you to keep up-to-date on tax issues and honest in your reporting. Here are a few things that could trigger the IRS to want to take a closer look at your taxes:

  • Meals, Travel, Entertainment - Often personal travel expenses get co-mingled in business travel, which may prompt the IRS to take a look. 
  • Income - According to the SBA, the more income you earn equates to a higher risk of an audit. 
  • Cash Business - Because there is no paper trail when you accept cash, it's easier to not report. As a result, the IRS is suspicious of cash businesses. 
  • Exorbitant deductions 
  • Claiming 100% business use of your vehicle - Since most home business owners use their car for personal and business, it can be risky to claim your car is used only for business. This is true for other expenses such as mobile phones and Internet, in which you often use them for both business and personal. Instead, determine the percentage of time used as a business, and deduct that.
  • Your return is outside statistical norms. The IRS sometimes runs random screenings comparing returns against others. If yours is a lot different from returns that are deemed similar to yours, it might be flagged for an audit.

9) Do I need to have a federal tax ID number (FEIN) for my home business?

If you are a sole-proprietor without employees or single-member LLC without employees, you don’t need an FEIN -- you can use your social security number. Any other business set-up does require an FEIN. With that said, since FEIN numbers are free, it doesn't hurt to get one. Depending on the type of home business you run, you may be asked to give your Social Security number. If you have a business FEIN, you can give that instead, and protect your social security number.
 

10) Why am I being asked by a client to fill out a W-9 Form?

The W-9 Form is the official IRS form used by a company when they want you to send them your taxpayer identification number (either your social security number or FEIN). It's similar to the W-2, except it's used for independent contractors, consultants, and other self-employed workers. This form helps the company properly fill out a 1099-MISC tax form, that it sends to you at the end of January so you can do your taxes. It also sends a copy to the IRS.

11) Does a home business always have to pay taxes at the end of the year?

Not always. Self-employed individuals are required to pay any personal income tax and self-employment tax due at the end of the year. This burden can be lessened with various tax deductions. With that said, there are many factors that go into whether or not you end up owing taxes. First, if you're in a dual or multiple-income household, the taxes paid by other members (or your job) may offset the taxes you owe on your business assuming other members were eligible for a refund. Another consideration is your business structure. A sole proprietorship or single person LLC, can file a Schedule C and do your taxes normally. However, corporations or partnerships require the business to file taxes. Finally, home businesses are required to pay estimated taxes. Whereas an employer would take taxes from your income on every payday, as a home business owner, you need send in estimated tax payments four times a year. When you do your taxes, you subtract what you sent in similar to how you subtract what paid from an employer.

If you don't pay estimated taxes, but your tax burden is less than $1,000, you'll probably be okay. But if you owe $1,000 or more, you could face penalties and additional fees. 

12) What is Self-Employment Tax and is this in addition to the regular taxes I will pay at the end of the year?

Yes it is different. Self-employment tax is paid on top of any other taxes you may owe. It is the self-employment version of FICA tax, which is usually paid by employers for Social Security and Medicare. It is due on your net earnings from self-employment. The Schedule C form, your tax software, or a tax professional can help you make the calculation. The good news is that half of your self-employment tax is deductible.

13) Can I write off my health insurance payments?

If you are self-employed, pay for your own health insurance and have a net business profit, you are able to deduct the full cost of your health insurance premiums as a personal deduction. If you breakeven in your business or experience a loss, you are able to still deduct your health insurance premiums as a medical expense on a different area of your tax form.

14) What is the likelihood that I will get audited?

According to the SBA, less than 2 percent of returns with income from $25,000 to $100,000 get audited. It goes up to just over 2 percent for those who make more, and drops to 1 percent for those making less than $25,000. Income alone isn't the only factor in audits, so you want to make sure you avoid an audit red flag (see questions #8).

15) What can I expect if I get audited?

First, being flagged for an audit doesn't necessarily mean there is something wrong. The IRS randomly scans returns and compares them against statistical norms. Or, if someone you've done business with is under audit, your return might be flagged as well. Note that if you are audited, the IRS will contact you by mail, not by phone. In most cases, the IRS will ask for information such as receipts or logs. Only 25% of IRS audits actually involve a face-to-face meeting, the other 75% are mail audits. However, if the information you're required to submit is too much to mail, you can request a face-to-face meeting. The IRS will review your information and make a determination about whether or not you owe more.

Disclaimer: I am not a tax specialist or licensed tax attorney. The information provided here should be used as a general guide. For specific questions about your own taxes, please consult a tax specialist or refer to the official IRS publications.