Monday, March 13, 2006

The relief of having completed my taxes...and the lessons I learned

Last night, Michael and I got started talking about taxes. In the end, I was inspired, and opted to work on my taxes rather than watch a little TV together. Of course, Michael got sucked into it too, as I had him double check my work. About three hours later, I was finished: my taxes for the year are now done!

This was the first time I'd ever filed my taxes as a freelance writer, so I learned a few things that I feel I should pass on to other inquiring freelancers. I wrote a post about it some months ago, when I was first researching the matter, but now I definitely have more tips to share.

First, the basics:

Forms you'll need:
1040, of course
Schedule C (1040)
4562 - Amortization & Depreciation - for claiming the expenses of any business equipment you bought during the year
8829 - Business use of your home - for claiming a home office

Expenses versus income:
The point of this is to ensure that the income you are claiming really is your net income. For example, you may get x amount of payments from publications over the year, but if you think about it, you've also had y amount of expenses, which you wouldn't have had as an employee - the business you work for pays for advertising stuff, office supplies, etc. So to find out your actual income, known as net income, you subtract your expenses (y) from your gross income (x). And yes, you can have a loss instead of a profit. Schedule C will walk you through all of this.

Hopefully you'll have kept good records throughout the year. I, for one, like to record every payment I receive and every expense I accrue into Excel spreadsheets. I have a separate one for income, with a page for each publication or employer I write for, and an overview page that tallies up the totals from each page. My expenses spreadsheet has the same overview page, with separate pages for each of the expense categories: office expenses (such as internet costs), office supplies (envelopes, printer ink, etc.), advertising (my website), etc. A book that I found very helpful in dividing my expenses up into these categories was 422 Tax Deductions for Businesses & Self-Employed Individuals, by Bernard B. Kamoroff, C.P.A.

Office equipment expenses:
This category was not nearly as simple as I'd thought it would be. First of all, you need a separate form, the 4562, the total from which is then entered onto the Schedule C. This form was by far the most complicated. What it boils down to is that you can depreciate your office equipment (i.e. computer, printer, scanner), which means you divide the cost up between several years, and only use a portion of the cost to deduct from your gross income each year. However, if your office equipment expenses are less than $105,000, you can claim the full price for the one year, by entering them onto the form as Section 179 instead. It's a very confusing form, so I'm not going to go into it any more than this.

I should also mention that if you use said office equipment partly for personal use, you need to know what percentage of the equipment's use is for business. You can only expense this percentage of the equipment's cost. It's important to keep records of your business use vs. personal use, just in case you are audited, so that you can prove your claims. If you use MS Outlook, you can set the journal up to track your use of programs such as Word, as well as your emails sent to certain contacts. You can also manually create journal entries to document internet usage, etc. Although this may seem slightly tedious, it'll make an audit much easier if all you have to do is turn over records that prove what you claimed on your returns.

Home office deduction:
From everything I've read, I highly recommend not claiming this expense. First of all, I read documentation that claimed the home office deduction is the number one red flag that triggers the IRS to audit people. Apparently it is a deduction that is very much abused. However, if you decide to claim it anyway, keep in mind the following:

Your home office space must be used only for your business. This means you can't have games on your "office" computer, can't have personal bills or files in your "office" desk, etc. Everything in the home office space must be strictly work-related. Figure out the percentage of your home that is used only for work, and claim that percentage of your rent or mortgage as office space rent. You can also use this percentage to figure out the home office expenses of utilities and home repairs.

Claiming a home office deduction can bite you in the @ss if you own your home. If you are claiming a home office deduction for a home you own, you'll end up owing on tax returns when you sell the house. Not a pretty thought.

Even if you don't claim the home office deduction, you still can claim your internet costs - that is, what you use for work. To figure this out, your computer records will once again come in handy. You just have to be able to prove that whatever percentage of your internet bill you are expensing is actually the percentage of the service that you use for work.

Hobby versus business:
This is one of the trickier things. To be able to claim your expenses, you have to be a business and not a hobby. This means that you have to be doing what you're doing with a profit as your goal. Of course, the easiest way to prove you are a business is to actually make a profit. Even if you don't, however, you can prove you are a business by conducting yourself like one: keeping good records, having advertising materials such as business cards, brochures, etc., having separate accounts and phone lines for your business, and things like that. A great source on this subject is the book Home Business Tax Deductions: Keep What You Earn, by Stephen Fishman.

I hope all of this is a help to any other freelance writers filing their taxes for the first time. Of course, I am by no means an expert, only relaying the information I have already come across myself. I highly recommend checking out the books I mentioned or similar literature that will help you fill out your tax returns.

Good luck to you!


Anonymous said...

I would encourage you to take the home office deduction if you qualify for it. It is not a red flag for the IRS as some suppose. A great resource that covers that area and others that you might find helpful is Tax Deductions for Professionals by Stephen Fishman by Nolo Press. My CPA has verified the advice in that book as correct and it sure has helped me. I hope it helps you save more of your hard earned money.

Katharine Swan said...


Thanks for visiting, and for offering your input. However, I'd rather be safe than sorry in this case.

My reasons for not taking the home office deduction are as follows:

* We own our home. Since I don't want to owe business taxes on the house when we sell it, I'd rather not claim it as a business expense.

* I don't have a space that I use exclusively for work. My office, desk, and even my computer are also used for personal purposes. With equipment such as computers, you can specify what percentage of use is for business; but according to all the tax books I've read, as well as the IRS information packets, a home office must be used EXCLUSIVELY for business. Mine is not.

* I'd rather be safe than sorry. Keeping more of my hard-earned money, as you put it, is not worth claiming expenses that I don't legally deserve, and can't prove if I get caught.


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