February 4, 2009 12:00 am

What Self-Employed Individuals Should Know about Filing Their Returns

Self-employed individuals who file Schedule C (or C-EZ) to report the income and expenses from their business activity should be aware that the IRS is on the lookout for those who underreport their income or overstate their deductions. Here are some tips to help you submit an accurate return and avoid red-flagging your return for audit.

Watch Limitations on Deductions

While most business expenses are deductible, the tax law has numerous rules to limit the amount or timing of certain items. Pay attention to these:

  • Meals and entertainment expenses-only 50% are deductible.
  • Start-up costs-only costs up to $5,000 are deductible in the first year, with excess amounts amortized over 15 years (if costs are substantial, no first-year write-off may be allowed).
  • Vehicle purchases-for passenger cars purchased in 2008 which are eligible for bonus depreciation (i.e., they are new cars), the limit is $10,960; for light trucks and vans, the limit is $11,160.

Note Business Deductions that Aren’t Deductible from Business Income

You may be able to claim certain deductions related to your business, but not as business deductions. This means that the deductions cannot be used to reduce the income that is subject to self-employment tax. These deductions, which are claimed as adjustments to gross income on page 1 of your Form 1040, include write-offs for:

  • Health insurance-100% of the premiums for you and your family (premiums for your employees are a business deduction).
  • Qualified retirement plans-contribution on your behalf to any qualified retirement plan, such as an SEP (contributions for your employees are a business deduction).
  • Health savings accounts-contributions for yourself (contributions for your employees are a business deduction).
  • Domestic production activities deduction-a 6% deduction in 2008 if your business manufacturers, grows, mines, or otherwise produces something in the United States.

Check Home Office Deduction Eligibility

If you work from home, you may be entitled to deduction a portion of your personal living expenses as a business deduction. Usually, to qualify the home office must be your principal place of business and you must use the space regularly and exclusively for business. Also, the income from the home office must be at least as much as your deduction (a home office deduction in excess of this income can be carried forward and used in a future year).

If eligible, complete Form 8829, Business Use of a Home, to determine the amount of the home office deduction. This form is attached to your return.

Don’t fail to claim this deduction if you’re entitled to it because you fear it’s an audit red flag. Just be sure to follow the rules and you’ll prevail, even if your return is questioned.

Get Your Records in Order

Certain legitimate business expenses are not deductible unless you have the proper records to back them up. To protect yourself, be sure to have the necessary receipts and written records for:

  • Travel expenses
  • Business gifts
  • Meal and entertainment expenses
  • Business use of your personal vehicle

Check for New Tax Breaks

Don’t assume that entries from last year will apply to this year’s return. Cost-of-living adjustments to numerous tax rules, as well as several new tax laws, present new opportunities for you to save on your return. New for 2008 returns:

  • 50% bonus depreciation on eligible equipment purchases
  • First-year expensing up to $250,000
  • Higher limit for SEP contributions ($46,000)

Caution: The income limit for purposes of the Social Security portion of self-employment tax for 2008 is $102,000 (up from $96,800 in 2007). There is no cap for purposes of the Medicare portion of self-employment tax. Self-employment tax is figured on Schedule SE, which is attached to your return.


Tax Glossary

Installment sale

A sale of property that allows for tax deferment if at least one payment is received after the end of the tax year in which the sale occurs. The installment method does not apply to year-end sales of publicly traded securities. Dealers may not use the installment method. Investors with very large installment balances could face a special tax.

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