self employed working from home

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Earlier, working from home was not a very common phenomenon for the bread earners of the family. However, over the years, the dimensions have changed. Since the last few years, many people are choosing to earn while staying inside their houses. There is a significant surge in the number of freelancers and self-employed persons employing such practices in the US.

A considerable chunk of the populace in the United States runs their business from their home space itself. As per the BLS data for last year, there are more than 16 million self-employed individuals in the United States. Many of them do not want to opt for the hassle of renting a separate workspace for doing their work. These people find working from home a great way to balance family time and professional commitments.

2020 saw the unprecedented arrival of the Coronavirus outbreak. The United States remains one of the worst affected countries due to the virus spread. Now, due to the COVID-19 pandemic, we can see a manifold rise in the number of people working from their home’s comfort. These people include not just the employees who are following a remote work system, but also many self-employed individuals.

Meaning of a Self-Employed Individual

As per the definition, the Internal Revenue Services (IRS) has laid out; a self-employed person is an individual making a living through the medium of working for himself. He does not work as an employee for some other entity and is not a corporation’s stakeholder.

The individual should meet the following conditions as per the IRS:

  1. The person undertakes any business or trade as a sole proprietor or as an independent contractor.
  2. The person works as a partner in a partnership firm. He can even be a member of an LLC, that carries on any trade or business, or
  3. The person is in business for his own sake, and it includes a part-time business.

Introduction to the Home Office Deduction for the Self-Employed

Many self-employed individuals are working from their homes. The issue is they cannot claim the conventional business expenses associated with having an office space. However, the IRS has cut some slack to the small business owners working from home. They also have the opportunity to lower their tax burden. The IRS has put in effect the Home Office Deduction scheme for the self-employed individuals in the US.

The Home office deduction will allow self-employed persons using their homes exclusively and regularly for business purposes to claim relevant expenses for tax purposes. The term home refers to a house, an apartment, a mobile home, condominium, and other similar properties. The costs include proportionate house rent, insurance, repair overheads, utility bills, and real estate taxes.

Conditions for being eligible for Home Office Deduction

A self-employed individual who wants to avail of the Home Office Deduction must comply with the following criteria:

A self-employed individual can claim the home office deduction for a self-owned home as well as a rented house. It is available for any form of a house where the self-employed resides. No deduction is available for any temporary lodging space or a stay in a hotel.

Exclusive Use:

The home must cater to the condition of exclusive and regular usage. The space you are using should remain reserved only for conducting your business needs. It must be located in a distinct room or group of rooms in the house. If you use the space additionally for other personal purposes, you are not eligible for the deduction. However, there are exceptions to this condition like a licensed daycare service for children and elderly or use for storage of inventory and sample.

Principal place of business:

The individual can claim the home office deduction if his home is the principal place of business. He should use his home office for business administration activities like business meetings, customer billings, and maintaining business records.

A person who is an employee in a company and also runs a part-time business can even claim the home office deduction if he meets the required conditions. However, employees working from home solely for their employment purposes cannot claim the deduction.

Calculation Approaches for the Home Office Deduction

IRS has laid out two different methods for the calculation of home office deduction.

One should choose the method which helps them claim a higher home office deduction. The two approaches are; Actual Expense Method and the Simplified Square Footage Method.

The Actual Expense Method

As per the actual expense method, one can claim a deduction for real expenses incurred. The self-employed individual can claim overheads such as repairs and painting of the home office. One can get benefit deduction for expenses such as insurance, home utilities, loan interest, and real estate taxes based on the proportion of home used exclusively for official purposes. In most cases, the actual expense method is recommended when a person has a big house and takes up a large space for exclusive business needs.

Let us take a hypothetical case to understand the actual expense method. Alex is a self-employed individual who works in a home office. His office takes up a space of 500 square feet in his 2500 square feet home. It means Alex is eligible for deducting 15 percent of the overall home expenses mentioned above. He can claim a full deduction for costs directly attributable to his home office.

Points to remember if you use the Actual Expense Method for claiming Home Office Deduction

  • Maintenance of Accurate Records:

Keep Proper Records of all expenses used for the calculation under the actual expense method. Safely maintain receipts and bills related to expenses such as repairs, equipment purchases, and electricity.

  • Claiming Depreciation:

An individual who opts for the actual expense method has to record a depreciation expense. He needs to claim the proportionate depreciation. One must understand that they will be subject to capital gain tax even when he is not usually liable. The percentage of the home used as an office, on which depreciation is claimed, will be liable for capital gain tax on its sale.

The simplified Square Footage Method

Under this method, the IRS has pre-specified a fixed rate per square foot for the given area covered by the office. It is much simpler to calculate and does not involve the hassle of maintaining expense bills and depreciation calculation. A self-employed individual can use this method if he has an office space of less than or equal to 300 square feet. The deduction available from IRS is $5 per square foot. A person can get a maximum of $1500 as a home office deduction under this method. Hence, the simplified square footage method works best for individuals working in a single-room with small-scale operations.

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