Contractors: Keep receipts, consider home office

For independent contractors, tax time can be confusing. Forget the 1040EZ. If you’re self-employed, it can appear that an entire tree gave its life just so that you can fill out all the forms the government requires.

But the reward for successfully completing Schedule C, Schedule SE and all the other documents required for independent contractors is that you get to deduct the expenses associated with your business.

This is key, says Boulder certified public accountant Corine Hauser, because self-employed workers must pay the 15 percent in FICA taxes that an employer would normally pay for them. For independent contractors, income is taxed after expenses are deducted.

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“Every dollar that you spent as an expense saves you 15 percent,” says Hauser, who works for Waters Accounting Plus in Boulder.

Periodically the Internal Revenue Service changes the criteria for what expenses can be deducted or how they can be deducted. But this year, local accountants say the IRS hasn’t done much tinkering.

The major change is that independent contractors can now deduct 60 percent of their health insurance premiums. Eventually that may become 100 percent, but it’s still being debated in Congress.

Otherwise, expense deductions remain much the same. To determine what the IRS considers a legitimate business expense, check the Schedule C in the federal tax booklet.

Schedule C lists a series of criteria, ranging from advertising expenses to travel. Although it’s possible to claim deductions without having receipts for them, if you’re audited and you can’t produce a receipt, chances are good that the IRS will disallow the deduction.

The key to assuring that you deduct all your expenses is to constantly ask yourself if what you’re buying has a work-related purpose. If you buy a pen, save the receipt. If you take a client out to lunch, save the receipt. If you subscribe to a trade journal, save the receipt. If you hire an accountant, save the receipt.

Hauser says the biggest mistake independent contractors make is not keeping track of the miles they drive for work-related activities: “People end up having to guess their mileage at the end of the year.”

You can track mileage in several ways. You can keep a log in your car and write down the odometer settings at the beginning and end of a business trip. You can keep a calendar and record “post office, 5 miles.” Or, if you have another car, you can designate one vehicle as business only and then deduct the entire year’s mileage.

Another complicated deduction is for a home-office.

Ray Athey, owner of Athey & Associates public accounting firm in Broomfield, says that traditionally a deduction for a home-office is supposed to raise a red flag with the IRS, but he’s never had a client audited for taking a home-office expense. This includes day-care providers who deduct their whole house, Athey says.

“The IRS is easing up on home offices,” Hauser adds, citing a recent case in which the courts decided in favor of a doctor whose home office was disallowed by the IRS.

The most important thing to consider when deducting a home office is that it really is an office.

“You need to be cautious that it’s for exclusive use,” Athey says.

To deduct a home-office, measure the square footage. The IRS allows you to deduct that percentage of your rent or mortgage payment and utilities, minus depreciation if you own your own home. You will need to fill out a separate form for this.

Hauser highly recommends against deducting a home-office if you own your home and are planning on selling it.

“When you sell your house the gain is normally tax-free, but if part of your house is a home-office and it’s depreciated, then some of that gain is a business gain, because part of your home is business property.”

If you plan to hold on to your house for years, or if you rent, then it makes sense to deduct a home-office, Hauser says.