Tax Deductions for Contract Workers, Freelancers and Home Business Owners
It’s tax time! While doing taxes is a hassle, one of the many perks of working at home as a contract worker, freelancer or home business owner are tax deductions.
Disclaimer: I’m not a tax expert. This article is provided for general information. For more details visit the IRS online.
Hobby Vs. Business Deductions
Did you know that the IRS allows you take deductions for hobby expenses? Maybe you make jewelry and sell at Christmas time, or write poetry that you sell magazines. If your participation in the activity is mostly for the love of it and not to make money, then it’s considered a hobby. The good news is that hobby expenses may be eligible for deductions as well.
If your goal is to make a living working at home and you’re doing everything you need to do to make that happen, then your activities can be considered a business, even if you haven’t made any significant income yet.
When it comes to deductions, both businesses and hobbies can take them, but hobbies are limited in how much they can take. The IRS only allows deductions up to the amount the hobby earned. If you made $1,000 with your jewelry and your expenses were $1,500, you can only deduct up to $1,000. Hobbies are not allowed to show a loss, whereas a business can deduct all business-relates expenses even if it results in a loss (within reason). There is a limit to how long you can show a loss in a business before the IRS considers your effort a hobby. Generally, you need to have a profit 3 out of 5 years for the IRS to see you as a business.
To deduct your hobby expenses:
1. Make sure your project is indeed a hobby and not a business. Remember, if your focus is to make money and you’re doing the activity required to make money (i.e. marketing), then it’s a business.
2. Keep track of all your hobby-related expenses, such as the cost of materials. Retain a file of all your receipts and statements to verify your expenses.
3. Keep records of your income.
4. Use Schedule A of your 1040 for file your deductions. (Businesses use Schedule C).
To learn more about hobby deductions, read the IRS’s Publication 535, the section on Not-For-Profit Activities. (PDF)
To Deduct Business Expenses
If you’re goal is to make a living as a contract worker, freelancer or home business owner, you want to keep track of your expenses just like you do in a hobby, but you’ll file a Schedule C on your tax return.
Expenses to consider include:
- cost of materials,
- website hosting,
- Internet access,
- travel to meet with clients or attend conferences
Any expense you have that is required as part of running your business could be deductible.
If you have a loss, make sure you have proof of all you’ve done to turn your home based activities to a career such as your blog, applications, resumes or portfolio, and marketing. It will help prove your point if you’ve formally created a business (i.e. with a licence) and/or have a separate business bank account. The IRS will accept business losses only for so long.
To learn more about business deductions, read the IRS’s page on Deducting Business Expenses.
Home Office Deduction
The IRS has rules about whether or not you can take the home office tax deduction for your contract or freelance work, or home business. To qualify, your home office must be used regularly and exclusively for business. Regularly means that you’re in your office on a regular basis, not just on occasion. Exclusive means that you can’t use the area for personal endeavors. If only part of a room is used for your writing business, you can claim that section, but you must measure it and use only that area in your calculations.
Another requirement is that your home office must meet at least one of the following:
- It’s your principal place of business. That means you can’t have a office elsewhere.
- You see clients or customer there.
- It’s a structure detached from the main house.
There are two exceptions to the rule that your home office is for business only:
– You run a day care center
– You store inventory for your business in a part of your home.
If you’ve met the requirements listed above, you might be able to deduct a percentage of the expenses used to run your home including:
- Real estate property taxes
- Mortgage interest
- Home depreciation
- Rental payments
- Home owners insurance
- Travel expenses to meet with clients
Starting in 2013, the IRS came out with a simplified home office deduction which is $5 times the square footage of your office. If your office is in a 10 by 8 room, your home office deduction is 180 times $5.00 or $900. This is easier than calculating depreciation and all the other factors in the old method. However, you may want to calculate both methods to see which offers the best deduction.
For information about how to claim the home office tax deduction, talk with a tax expert or read IRS Publication 587: Business Use of Your Home. (PDF)
(NOTE: I’m not a tax expert, so please consult the IRS or a tax professional for more information and tips on home office tax deductions.)
Leslie Truex is an ideaphoric writer, speaker, entrepreneur, social worker and mom trying to do it all from the comfort of her home. Since 1998, she's been helping others create careers they love by providing work-at-home information and resources through Work-At-Home Success.
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