Q: This past year was my first year as a full-time freelance employee. I will be filing a 1099 at tax time. What kinds of home-office deductions are standard? Also, will I be penalized if I haven't paid estimated taxes quarterly throughout the year?
A: When you work from home, you can deduct any expense that you can reasonably justify incurring as part of operating your business. That includes office supplies, equipment, software, marketing costs, transportation costs to business meetings, subscriptions to trade publications, as well as health insurance. For goods that last more than a year, such as computers, copiers, or furniture, you need to take depreciation into account and deduct a percentage of an item's cost over a period of years. You shouldn't deduct the expense all at once in the tax year you bought it. (See IRS Publication 534 for details on depreciation.)
You can also deduct part of your rent. If your office occupies 25 percent of your home, then you can deduct 25 percent of your rent from your taxes. If you own your residence, you can deduct the home-office percentage from certain homeowner costs. Whether you rent or own, the IRS allows you to deduct the same percentage from your utilities that you're deducting for your office space.
Ideally, the IRS wants you to keep all business and personal expenses separate. For example, if you're deducting rent on a room in your apartment, that room should be used exclusively for business. Sometimes, you'll encounter "mixed-use" gray areas. Say you have a computer for both personal and business use because it isn't practical for you to have two separate computers. The best way to satisfy the IRS that you're claiming a legitimate deduction on your computer is to keep a log documenting how often you use it for business and how often for personal use. Then, claim only the business percentage.
By the way, 1099 forms are filed by the companies that hired you. You don't have to file any 1099s yourself. Regarding your estimated tax question: If you neglected to pay your quarterly estimated taxes throughout the year, the government will charge you about a 5 percent penalty on those taxes. In the eyes of the IRS, it's as if it were a bank and you're paying interest on money you began "borrowing" as soon as you were late with the first payment. Use Form 2210 to figure out how much of a penalty you owe, or file it and the IRS will figure out your penalty for you before sending you a bill.
A good resource for these types of self-employment issues is “Working for Yourself,” a book put out by Nolo Press, which specializes in publications about legal matters.
Jean Chatzky’s Bottom Line
This week: Tailor your finances to aid student aid
You'll want to start planning for financial aid eligibility well before your child learns to drive. Why? Because in the aid application, many private colleges want to see your tax return for the year beginning January 1 of your child's junior year in high school. The trick is to minimize your income or draw assets down before that point. Three savvy and legitimate ways to do that:
- Re-mortgage your house to fund renovations that will reduce your home equity and at the same time your net worth.
- Reduce your assets by drawing down savings to pay off credit card balances.
- And more dramatically, leave a job — where the income stream is steady — to start your own business.
Jean Chatzky is the financial editor for “Today,” editor-at-large at Money magazine and the author of “Talking Money: Everything You Need to Know About Your Finances and Your Future.” Copyright © 2004. For more information, go to her Web site, .