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How Should I Prepare to Pay Taxes on Home-Based Biz Income?

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I'm starting a home-based business, and I don't want to get caught with my pants down during next year's tax season. What steps should I take to prepare myself for paying taxes on this business income?

Many entrepreneurs that are just starting out opt to work out of their homes instead of incurring the costs of renting office space. Those that work from home will need to be well-versed in the tax reporting requirements that the IRS often scrutinizes.

Tax filing requirements will depend on the type of business entity that the entrepreneur has started. For our purposes, we'll focus on a sole proprietorship or a single-member LLC treated as a disregarded entity for taxes. In both of these cases, the entrepreneur will file a Schedule C and SE with his form 1040 to report his business income and expenses. In addition, he will likely also be subject to self-employment taxes and have to file estimated taxes each quarter. The general rule is that you must pay self-employment tax or 15.3% of your wages if you had net earnings from self-employment of $400 or more. However, half of your self-employment taxes are deductible. In addition, you must pay estimated tax for 2013, if you expect to owe at least $1,000 in tax for 2013, after subtracting your withholding and refundable credits. In addition, if you expect your withholding and refundable credits to be less than the smaller of: 90% of the tax to be shown on your 2013 tax return, or 100% of the tax shown on your 2012 tax return. The only other way to avoid filing estimated taxes is if you had no tax liability for the 2012 tax year. Thus, if this is your first year in business, you won't need to worry so much about estimated quarterly filings.

On the expense side of the business, you may be eligible to claim the home office deduction. This deduction is specifically allocated to the portion of the home that you regularly and exclusively use for your business (reference: IRS Publication 587). Generally, you can deduct the business portion of these expenses: real-estate taxes, qualified mortgage-insurance premiums, deductible mortgage interest, rent, casualty loss, utilities, insurance, depreciation, security systems, and repairs. You can also deduct expenses associated with a separate free-standing structure that you use exclusively and regularly for business. In terms of how to calculate the deduction, there are some changes for 2013. Instead of claiming the deduction by completing the 43 line Form 8829, taxpayers may soon be able to complete a significantly simpler form. Specifically, the home office deduction is calculated at $5 per square foot. There's a catch though. Taxpayers will only be able to use this simple option if their home expenses do not exceed $1,500 or 300 square feet. In addition, the new option won't be available until the 2013 tax year, which you'll be filing in the beginning of 2014. You can always utilize the old way, but that requires more paperwork and can be time-consuming.

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