Form 8829 is the form used by sole proprietors to calculate and report Expenses for Business Use of Home (aka “The Home Office Deduction“).

Step 1: Download the Form and the Instructions.

Step 2: Fill-in your name and SSN.

Step 3: Fill-in “Part I – Part of Your Home Used for Business”

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• On Line 1, enter the total square footage that you use regularly and exclusively for your business. [Note: When they say "exslusively" here, they really mean exclusively. If you use the space for anything else, you can't count it for your Home Office Deduction.]
• On Line 2, enter the total square footage of your home.
• Divide the square feet used for business by the total square feet of your home, and enter the resulting percentage on Line 3. Also, as long as your business is not a Daycare facility, skip to Line 7, and enter the same percentage that you entered on Line 3. This percentage is the “Business Percentage” of your home. It will be used later in the calculations for determining how much of certain expenses you’ll be able to deduct.

Step 4: Fill-in “Part II – Figure Your Allowable Deduction”

• On Line 8, enter the total profit from your business. (This can be taken from Line 29 of Schedule C.)
• For lines 8-35, simply follow the instructions printed on the form. It may not intuitively make sense while you’re filling it out, but here’s what’s happening:
  • In column A, you’re entering and totaling all the expenses that relate only to the business-use portion of your home. (For instance, if you repainted your home office, the costs for the paint job would go here.)
  • In column B, you’re entering costs that relate to your entire home (rent, home mortgage interest, homeowners’ insurance, ultilities, etc.). Then you end up multiplying all of these “indirect expenses” by the Business Percentage of your home (from Line 7), thus giving you the portion of these expenses that relates to your home office.

Step 5: Fill-in “Part III – Depreciation of Your Home”

If you own your home, you can include an expense known as depreciation in your Home Office Deduction. Here’s how it’s calculated:

• On Line 36, enter the smaller of the home’s fair market value or it’s adjusted cost basis (the amount you paid for it, minus any amount that you’ve already deducted as depreciation in prior years).
• On Line 37, enter the value of the land that your home is located on.
• Subtract Line 37 from Line 36. The difference (entered on Line 38) is known as the basis for the building.
• Multiply Line 38 by Line 7 (Business Percentage of Home). Enter the product on Line 39. This is known as the Business Basis of Building. This is the amount that you will be allowed to deduct, spread out over a period of several years.
• For Line 40, you’ll enter the percentage of the Business Basis of the Building that you’re allowed to deduct this year. (See the chart on Page 3 of the instructions.)
• Multiply Line 40 by Line 39. This is the amount of depreciation for your home that you can include in your Home Office Deduction this year. (Also enter this amount on Line 29.)

Step 6: Fill-in “Part IV – Carryover of Unallowed Expenses”

Every year, your Home Office Deduction is limited to your profit from your business. If your expenses for the business use of your home exceed the profit from your business, you’ll have to fill out Part IV of Form 8829. (What ends up happening is that the remaining expenses end up being carried forward, and you can add them to your Home Office Deduction in the following year.)

Step 7: Go Outside and Play.

Jessica (realtor) asks:

Michael, this year I started working part-time as a realtor. I have been told that I will be receiving “1099 income.” I think this means I will be an independent contractor. Is this right?

Answer:

Hi Jessica. You’re absolutely right. You are now considered an independent contractor, meaning you are self-employed for Federal income tax purposes. This will impact your tax situation in many ways:

• You will, most likely, have to make estimated tax payments at four (approximately quarterly) intervals throughout the year.
• You will have to fill out at least two additional pieces of paperwork (Schedule C and Schedule SE). Don’t worry though, if you do some homework ahead of time, you’ll be able to tackle these on your own.
• You will be subject to Self-Employment tax. (This is really just a different name for a tax that you and your employer would be paying if you were an employee.)
• You’ll be able to deduct many expenses that would otherwise be nondeductible.

Mark (independent contractor/Cutco sales rep) asks:

Hi Mike. I’m a college student, and I work part-time as a Cutco sales rep in an independent contractor role. What tax forms do independent contractors have to fill out? Am I going to need to hire an accountant this year? In other years my Dad has helped me to file my tax returns.

Answer:

Hi Mark.

There are a few different forms you’ll have to fill out this year that you haven’t seen before: Schedule C, Schedule SE, and possibly a Form 4562 or 1040-ES. Don’t worry though–you should be able to manage on your own. As an aside, anything called a “Schedule” is simply an attachment to a “Form.”

Schedule C: This piece of paperwork, an attachment to your regular Form 1040, details the revenues and expenses from your business. It’s fairly straight-forward, as most of your expenses will fall very clearly into one of the categories given.

Schedule SE: Another attachment to your Form 1040, this is where your Self-Employment tax gets calculated. After completing your Schedule C, Schedule SE is very easy and will probably take you only a few minutes.

Form 4562: If you purchased some equipment (a PDA/Blackberry for instance) for use in your business, this is the form that you’ll be using to determine how much you can deduct. This form is easily the most complicated of the ones here, so if you think you’re going to be using it, be sure to save plenty of time to work on it.

Form 1040-ES: If you’re going to have to make estimated tax payments, this is the form you’ll use to calculate how much to send in. (Generally, the amount you send in each quarter is simply equal to 1/4 of the total tax you paid last year.)

Best of luck with your sales!

Mark (graphic artist) asks:

I’ve been doing some freelance work this year, and I know that it’s going to count as self-employment income. I don’t know very much about taxes to be honest, but I’m learning a lot from your site. I know that Schedule C deductions are going to be my most valuable ones (because they save me money on self employment tax, if I understand correctly). What types of things will I be able to deduct on Schedule C?

Answer:

Hi Mark. You’re exactly correct. Your deductions that appear on Schedule C will be your most valuable ones, as they’re going to save you money on your regular income taxes and on your Self-Employment tax.

It’s generally pretty easy to tell which deductions will go on your Schedule C. Business expenses will show up on Schedule C, and other deductions will show up elsewhere. A good way to see what expenses you’ll be able to deduct on Schedule C is to simply look at the form itself.

Schedule C is the form used by sole proprietors (and, as such, independent contractors and owners of single-member LLCs) to report their profit or loss from a business. If you kept good records for the year as to your revenue and expenses, filling out this form shouldn’t be too difficult.

Step 1: Download the Form.

Step 2: Fill-in your personal information.

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The top of the form simply asks for some basic information such as your name, SSN, address, etc. It also asks for:

• Your business name (if different from your personal name).
• A description of the product or service you offer. (They’re only looking for a couple words here.)
• The 6-digit code that corresponds most closely to your type of business. The last 3 pages of this document have a table with all the codes listed along with the business-type they correspond to. If your business doesn’t match any of those given, enter 999999 for “unable to classify.”
• Your accounting method: Unless you’re quite certain that it’s accrual, the answer is “cash.”
• Whether or not you “materially participated” in the business. For most small business owners the answer is yes.

Step 3: Fill-in “Part I – Income”

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• Enter your total sales on Line 1.
• If you had any returns, enter that figure on Line 2.
• If you sell a physical product, enter your “Cost of Goods Sold” on Line 4. (Page 2 of Schedule C has a worksheet to help you calculate your CoGS.)
• Enter your total sales, minus your returns and your Cost of Goods Sold on Line 7. (This amount is known as Gross Income.)

Step 4: Fill-in “Part II – Expenses”

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• List each of your expense categories on the appropriate line.
• If you have any deductible expenses that don’t seem to match any of the given categories, total them up and enter the total on Line 27. Then list each of them on Page 2 (Part V – Other Expenses).
• Add up your expenses, and enter the total on Line 28.

Step 5: Calculate Your Profit/Loss

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• Subtract Line 28 (total expenses) from Line 7 (Gross Income) and enter the balance on Line 29.
• If you’re deducting expenses for the business use of your home (ie, Home Office Deduction) list the total on Line 30, and attach your completed Form 8829.
• Subtract Line 30 from Line 29 to arrive at your Net Profit or Loss.

Step 6: Pat yourself on the back/go get a cookie.

Much like forming a sole proprietorship, handling the taxes for a sole proprietorship is fairly simple. It really comes down to filling out just a few forms.

“Pass-Through” Taxation

Sole proprietorships are known as “pass-through” entities. What this means is simply that the profit (or loss) from the business is “passed through” to the owner of the business. Therefore, if you run a sole proprietorship, the profit from the business will show up on your regular individual tax return (i.e., Form 1040).

Schedule C

Schedule C is the form that you’ll use to compute the profit or loss from your business. As tax forms go, this one isn’t terribly complicated. For the most part, it’s just a list of all your revenues followed by a list of all your expenses.

Generally, the only time something isn’t straight-forward occurs when you have an expense that doesn’t seem to fit nicely into any of the expense categories listed. And even then, all you have to do is list it on the line for “Other Expenses” and (on Page 2 of Schedule C) give an explanation of what the expense was.

The end-result of Schedule C will be a figure known as your “Net Profit or Loss,” which you then carry over to your Form 1040 to be entered on Line 12 (Business Income or Loss). This income will be added to any salaries or wages that you or your spouse earn and will be taxed at the regular individual income tax rates.

The Self-Employment Tax

In addition to being subject to regular income tax, earnings from a sole proprietorship are subject to the Self-Employment Tax (SE Tax). The SE Tax is calculated (on Schedule SE) by multiplying your net earnings from self-employment by 15.3%.

At first glance, it may seem unfair to subject somebody to an extra tax simply because they are self-employed. However, the SE Tax is really just a substitute for the social security and Medicare taxes that are paid on salaries and wages for employees.

For employees, a social security tax of 6.2% and Medicare tax of 1.45% are withheld from each paycheck. Then the employer is required to pay a matching amount. As such, the employee is paying 7.65%, and the employer is paying 7.65% for a grand total of 15.3%. When you run a sole proprietorship, you are, in essence, both the employee and the employer, so you get stuck with both halves of the bill.

Deduction for One-Half of SE Tax

Because you’re paying a little bit of extra tax (the 7.65% that your employer would be picking up if you were an employee), Congress decided it would be fair to allow you to claim a deduction for the extra tax paid. As such, after using Schedule SE to calculate your Self-Employment Tax, you get to enter—on line 27 of your Form 1040—an amount equal to one-half of your SE Tax as an “above the line deduction.”

Simple Summary

• Sole proprietorships are known as “pass-through” entities because the income from the business is passed through to the owner, showing up eventually on his or her Form 1040.
• The profit or loss from a sole proprietorship is calculated on Schedule C.
• Earnings from a sole proprietorship are subject to the Self-Employment Tax (in addition to being subject to the regular Federal income tax). The SE Tax is calculated as 15.3% of your net earnings from self-employment.
• Schedule SE is the form used to calculate the Self-Employment Tax.