15 Home Business Tax Questions Answered
If you're interested in owning a small business, don't let the fear of doing taxes keep you from starting your entrepreneurial journey. While filing self-employment taxes requires more work for the individual, it also offers benefits to make the effort worthwhile. Here are answers to 15 common self-employment tax questions:
Should I Take the Home Office Deduction?
If you use a space in your home regularly (and exclusively) for business purposes, you should take the home office deduction. It can be a dedicated office in your basement, a detached garage, or a place where you store inventory and product samples.
Can I Deduct My Car as a Business Expense?
Yes, but only the portion of your vehicle expenses used for business purposes. Business travel can be calculated in miles driven and gas purchased. You must prove business use of the car through organized record keeping and receipts. By using a logbook or an app, you can ensure that each mile you drive receives categorization. The IRS provides a mileage rate which you multiply by your yearly business-related mileage to get your deduction. You can also deduct the care and maintenance of your car.
What Deductions Can I Take for Being Self-Employed?
Self-employment allows you to deduct all expenses that are justifiably essential to doing business, such as meals with clients, internet access for a home office, marketing costs to reach new customers, travel for work-related events, and insurance. Anything that's essential for business operations can be deducted.
How Many Years Can I Go Without Earning a Profit?
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" by the IRS, which is taxed differently. Continual business losses (meaning you deduct more than you make) leaves you at a higher risk of receiving an IRS audit.
Do I Need Receipts for All My Deductions?
Yes. Keeping receipts for all expenses and deductions is important because the burden of proof rests with you if you're audited by the IRS. There are many small business filing systems to keep receipts in order. You can also take advantage of business accounting software that will make generating tax reports easy.
How Much Self-Employment Do I Have to Report?
The IRS requires you to report all income. Depending on the type of home business you have, you might receive a 1099-MISC form; however, if you sell products or services directly, you may not receive any sort of income statement. That doesn't mean you don't have to report what you've earned. Report it all or pay for it later with additional fines.
Should I Hire an Accountant for My Home Business Taxes?
Any business accounting or tax service is deductible on your return. It's up to the business owner to decide whether or not to seek outside help when preparing taxes. It can be a wise investment to seek help for the first year or two until you understand the paperwork (and math) involved. Tax software is helpful if you don't have the budget for an accountant or tax professional and don't feel comfortable completing tax forms by hand.
Do I Need a Federal Tax ID Number for My Home Business?
If you're a sole-proprietor or single-member LLC, you don’t need a Federal Employer Identification Number (FEIN); you can use your Social Security number (SSN) instead. Businesses that have employees will need a FEIN. With that said, since FEIN numbers are free, it doesn't hurt to get one and use it in place of your Social Security number.
Why Is My Client Asking Me to Fill out a W-9 Form?
The W-9 is an official IRS document issued by a company when they need your taxpayer identification number (either your SSN or FEIN) for their own tax reporting. It's similar to the W-2, except it's used for independent contractors, consultants, and other self-employed workers. The W-9 form helps a company properly fill out a 1099-MISC tax form that it will issue to you (and a copy goes to the IRS) at the end of January with all your earning information.
Does a Home Business Always Have to Pay Taxes at the End of the Year?
Self-employed individuals are required to pay any personal income tax and self-employment tax each year. This burden can be reduced with various tax deductions and credits. Small businesses are also required to pay estimated taxes. Whereas an employer would take the necessary taxes out of every paycheck, the self-employed are required to pay an estimated tax. Depending on your income, this tax can be made in four payments throughout the year, or in one lump payment during tax season. If you don't pay estimated taxes, but your tax burden is less than $1,000, you'll probably be okay. If you owe $1,000 or more, you could face penalties and additional fees.
What Is Self-Employment Tax and Is This in Addition to the Regular Taxes I Pay at the End of the Year?
The self-employment tax is paid on top of any other state or federal tax. It's the self-employed version of FICA, which is the Social Security and Medicare tax that is usually collected by companies on behalf of their employees. It's due to 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 a portion of your self-employment tax can be deducted.
Can I Write off My Health Insurance Payments?
If you pay for your own health insurance and have a net business profit, you can deduct the full cost of your health insurance premiums. If you break even in your business or experience a loss, you can still deduct your health insurance premiums as a medical expense on a different area of your tax form.
What Is the Likelihood That I Will Get Audited?
According to the Small Business Association, less than 2% of returns with income from $25,000 to $100,000 get audited. It goes up to just over 2% for those who make more and drops to 1% for those making less than $25,000. Income alone isn't the only factor in audits, so you want to make sure you avoid all audit red flags.
What Audit Red Flags Exist for a Home Business?
As mentioned already, you shouldn't let the fear of an audit prevent you from starting a home business, but you should let the fear of an audit motivate you to keep up-to-date on tax issues and maintain honest books. Here are a few things that could flag an IRS audit:
- Income: The more income you earn could equate to a higher risk of an audit.
- Cash Only: There is no paper trail when you accept cash and it's easier not to report. As a result, the IRS is suspicious of cash businesses.
- Claiming your vehicle is used exclusively for business: Since most home business owners use their vehicle for personal matters as well as business, it can be risky to claim otherwise. Instead, keep track of the exact percentage of time the vehicle is used for business.
- Your return is outside statistical norms: The IRS sometimes runs random screenings comparing returns against others. If yours is different from returns that are deemed similar to yours, it might be flagged for an audit.
What Can I Expect If I Get Audited?
First, being flagged for an audit doesn't necessarily mean something's wrong. The IRS randomly scans returns and compares them against statistical norms. If someone you've done business with is under audit, your return could be flagged as well.
If you are audited, the IRS will contact you by mail, never 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. 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.
The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article may not reflect your own state’s laws or the most recent changes to the law. For current tax or legal advice, please consult with an accountant or an attorney.