5 Tax Tips for The Self-Employed

learn about taxes

Tax time can be extra taxing for the self-employed. What really do you count as income? What can you deduct as expenses? And why do you have to pay self-employment tax? Here are a few tax tips to help you prepare your self-employed tax return.

1. What is Self-Employment Income?

Self employment income can be any income that you earn as an independent contractor, a freelancer, or even money that comes in from a hobby. You don’t need to make much to be considered self-employed by the IRS.

2. What Business Expenses Can You Deduct?

The good news is that you can deduct any expenses that you incur to create income. Many people have expenses for items that are used for both business and personal, such as computers and internet costs. In those cases the IRS allows you to take a prorated amount as a deduction. Keep a log showing how much is business use, and how much is personal use to come up with your prorated deduction amount.

3. What is Self-Employment Tax?

When you work for someone else as an employee you have social security taxes deducted from your paycheck. Your employer pays an additional amount. When you are self-employed you pay both parts yourself as self-employment tax.

4. How Do You Report Self-Employment Income?

If you are not a corporation or a partnership you will report your self employment income and expenses on Schedule C. It is filed at the end of the year with your Form 1040. However, taxes are due through out the year. Estimated taxes are paid with form 1040-ES.

5. Where Can I Find More Information on Taxes and Self-Employment?

The IRS has many great resources to help self-employed people with their taxes. Start with these links from the IRS.

The Home Buyer’s Tax Credits, Now The IRS Will Help You Buy A Home

Ranch style home in North Salinas, California
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Once again the IRS has extended the First Time Home Buyer credit and now is a great time to buy a house!

What I find really exciting is now you don’t have to be a first time home buyer to get a modified version of the credit.

Here is the scoop. If you are a long time homeowner, defined as someone who has lived in their current home for at least 5 consecutive years, you can now qualify for the long time resident credit and get a tax credit of up to $6,500.

Here is how it works. For both the first time home buyer tax credit and the long time resident tax credit you must enter into a binding contract by April 30, 2010 and have closed escrow by June 30, 2010. Miss the deadlines by even a day, and you miss the credit.

You can claim the credit when you file your 2009 or 2010 tax return, or if you don’t want to wait, for homes purchased in 2009 you can amend your 2008 tax return.

The credit is 10% of the purchase price of the home, up to $8,000 for the first time homebuyers credit and $6,500 for the long term resident credit. The new home must be your principal residence for 3 years, or you have to pay back the entire credit.

There are some limits, the purchase price of the home must be less than $800,000 and a taxpayers modified adjusted gross income must be under certain limits. Just how much depends on when you purchase the home. For homes purchased before November 7, the credit starts to phase out at $75,000 MAGI, $150,000 for joint filers, and no credit is allowed for persons with Magi of over $95,000 or $170,000 for joint.
For homes purchased after November 6 the full credit is available for persons with MAGI of up to $125,000 ($225,000 for joint) and no credit is allowed for taxpayers with MAGI of over $145,000 ($245,000).
Find out all the details on the Home Buyers Tax Credits at the IRS site.

Now here is where I think it gets really interesting.

Make Tax Free Income From Your Personal Residence

Rich Dad, Poor Dad: What the Rich Teach Their Kids About Money–That the Poor and the Middle Class Do Not!
Robert Kiyosaki, of the Rich Dad, Poor Dad fame, said in his books that your home is not an asset. However, that was before the IRS made owning a home so attractive. Using a combination of the Home Buyers Tax Credits, Mortgage and Real Estate Tax Deductions, and the Tax Free capital gains from selling your home, it is possible to make large sums of tax free income from your home. Here is an example of how it might work.

You, as a first time homebuyer, buy a home for $80,000 on January 1, of 2010. You put 10% down ($8,000) and take out a 30 year fixed rate mortgage for $72,000 at 5%. Your monthly mortgage payments will be $386.51.

The first year, when you file your tax return, you get the $8,000 tax credit, in other words, the IRS just paid your down payment. You will have paid around $3,300 in interest, and maybe another $1,000 in taxes, giving you a tax savings of about $1,000. ( I am using round numbers here just to make it easy.) That is a total of $9,000 you didn’t need to earn, and $9,000 you don’t need to pay taxes on.

Years two and three are not very exciting, you still get the tax deductions and save around $1,000 per year.

After 3 years you decide to sell your home. Let’s assume the market has made a recovery (which is not an unreasonable assumption for 3 years out) and your home has increased in value 25%, to $105,000. Let’s play with the numbers.

First lets see how much cash it took to live in your home. (I don’t include insurance here, because even if you are renting your should be paying for insurance, and renter’s insurance and homeowner’s insurance cost about the same.)

Cash Out

If we add up the down payment ($8,000), the total monthly mortgage payments ($14,000) and the estimated property taxes ($2,400) we come to a total of $24,400 cash out of pocket to live in our home. But then we get to subtract the tax credit ($8,000) and tax savings ($3,000) to come up with a net out of pocket cost of $13,000. Not bad for three years of housing!

Now let’s see how the cash flows when you sell the home.

We sell the home for $105,000, but we have to pay the costs of selling the home ($8,400) and we have to pay off the mortgage ($68,000). That leaves us with cash in pocket of $28,600. Nice! Subtract from that the $13,000 cash out and you are left with $15,600 your don’t have to pay taxes on. Working a job and paying income taxes and social security taxes you would have to earn almost $20,000 to have the same amount of cash.

So by using the tax laws to your advantage you have lived in your house for free for 3 years and gained over $5,000 per year in cash flow.

In my book, that makes my home an asset!

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Tax Deductions for Your Online Business

Last year I wrote a post called 101 Tax Deductions for Your Online Business.   I was looking it over today, and thought I would point out a few of my favorites.

#10. Business related webinars and seminar fees. This is one of my all time favorite deductions, because I love to travel, and I love to be able to write off my travel. As long as the main purpose of your trip is business, and you spend the majority of your time in business related activities, you can write off all your travel expenses. So for example if your business is web design, and you go to a seminar for web designers where you can meet vendors, potential clients, and learn more about the latest advance in web design, you can write off your airline tickets, hotel fees, and 50% of your meals. Just make sure you have a real business purpose for the trip.


#58 – 66 Start up and organizational costs. Until you actually open your virtual doors and are “in business” you can’t deduct the expenses you incur while getting your business started. However, once the business is started you can take your start up and organization costs, and amortize them over “not less than 60 months”. With amortization, you don’t get to deduct all your expenses at once, but you do get to take a portion each year for 5 years. This can be to your advantage, because you will be deducting expenses in later years, when you will probably be making more money.

#98-101. Qualified Home Office. Sometimes thought of as an audit flag, a qualified home office done right is a great tax deduction. If you have a place in your home that is used regularly and exclusively for business, you can write off a portion of your mortgage, rent, utilities and home improvements. Just make sure you follow all the rules carefully and you will have a great tax deduction that will stand up to an auditor.

What are your favorite tax deductions for online businesses? What are the strangest things you have heard of people deducting for their business?