Taxes
Figuring Earnings Subject to Self-Employment Tax
In order to calculate your net earnings from self-employment, you will first have to calculate how much of your total earnings are subject to SE tax. To do this, use Schedule C or C-EZ(Form 1040). For more information about figuring earnings on Schedule C or C-EZ, see IRS Publication 334.
Depreciation and Section 179 Deductions
Depreciation is an annual income tax deduction that allows you to make up for the cost of a certain property. It lets you make up for the loss in value of the property due to wear and tear, deterioration, or obsolescence of the property. Most types of tangible property can de depreciated, such as buildings, machinery, vehicles, furniture, and equipment. Computer software, although considered intangible property, can also be depreciated.
Instead of taking depreciation deductions, you can also elect to take something called a 179 deduction. As a result of section 179 of the Internal Revenue Code, you can recover all or part of the cost of certain qualifying property, up to a limit, by deducting it in the year you first began to use the property.
MACRS? GDS? ADS?
MARCS stands for Modified Accelerated Cost Recovery System, and it is the depreciation method applied to assets placed in service after 1986. MACRS consists of two depreciation systems: the General Depreciation System (GDS) and the Alternative Depreciation System (ADS). These two systems provide different methods and recovery periods when calculating depreciation deductions.
Each item of property depreciated under MACRS is assigned a property class. The property class establishes the number of years over which the depreciation is charged. This period of time is called the recovery period. The nine property classes under GDS are 3, 5, 7, 9, 15, and 20-year property, as well as residential rental property and nonresidential property. The property classes most relevant to you as an independent contractor working from home are probably 5-year property, which includes computers and peripheral equipment (printers, scanner, etc…), and office machinery (such as typewriters, calculators, and copiers) and 7-year property, which includes office furniture and fixtures (such as desks, files, and safes).
GDS is popular because it has a shorter recovery period. This allows for greater deductions in your income tax. However, if you want to show a greater net worth, ADS shows a higher value for your property. The type of property and property class will determine whether to use GDS or ADS. Generally, you will use GDS unless you specifically choose to use ADS or if law requires it.
For more information about depreciation, see IRS Publication 946.
Business Use of Your Home
If you use your home for business use, you can claim a deduction for depreciation. In order to deduct any expenses related to having a home office, the IRS requires that the area be used EXCLUSIVELY and REGULARLY for managing your business. Fortunately, this definition also applies to something as simple as a desk, as long as it meets the requirement of being used exclusively and regularly for your business.
If you think you qualify for a deduction, the next step is calculate how much you can deduct. To do this, you will need to calculate the percentage of your home used for business and the limit on the deduction. To calculate what percentage to use, you will need to compare the size of the part of your home used for business with that of your whole house. You can be exact by measuring square feet or you can count rooms. The resulting percentage will be used to calculate how much of the operating expenses for your home are used for your business. You can then deduct a percentage of the total cost for rent, utilities, insurance, repairs and trash collection from your business income. If you own your home, you can even claim a deduction for depreciation. Below are two examples:
Example 1.
Your home is 1,000 square feet. Your office is 300 square feet (15 x 20 feet)
Your office is 30% (300/1,000) of the total area of your home. Your business percentage is 30%.
Example 2. Your home has five rooms of about equal size. You use one room in your home for business. Your office is 20% (1/5) of the total area of your home. Your business percentage is 20%.
For more information on claiming a deduction on your home office, see IRS Publication 587.
Computers and Other Listed Property
Most people don’t realize that they may be entitled to recover the cost of furniture and equipment that they use in their home for business through depreciations and section 179 deductions. If this is your first time, it can be a difficult and bewildering process, but with a little perseverance, it can be done. Next...