Bloggers, Vloggers and Podcasters – oh my!
The way people make money today has drastically changed thanks to the new, ever evolving, world of tech.
But what hasn’t changed is the fact that we still must pay taxes on every dollar that we earn.
And working from home poses a new set of interesting challenges when it comes to reducing those taxes through our write-offs and deductions.
Here’s what I mean…
As an online entrepreneur, for the most part, your working environment consists of you, your desk (or dinner table), your laptop, your cell phone, some video/audio equipment, your internet connection and possibly a needy pet that just won’t let you finish your work.
As you can see from the list above, there really isn’t much to write off (can’t write off the pet). Which means that there is a great chance of earning a lot of income and not have a lot of write-offs or deductions to go against it.
Not to mention that there are some very strict rules when it comes to working from home and deducting the expenses associated with it. Meaning that there is even a greater possibility that you won’t be able to deduct many expenses at all. Causing you to pay taxes on a higher amount and thereby pay more taxes.
So what can you do?
How can you maximize your deductions and save some money?
Your favorite uncle cousin has some tips and ideas for you.
Let’s start with the first thing I need you to do:
Earlier, I mentioned a few of the most common deductions that we, as online entrepreneurs, most likely are to deduct, however, if we really think about it there are a few more things that we can deduct.
The rules of deductibility are simple. For something to be deductible, it simply must have a clear business purpose.
Yep – that simple.
So, again when you really think about it, there are a lot things that we can deduct. For example:
There are probably a few things on that list that I forgot to mention, but if you close your eyes really tight and think hard I’m sure they will come to mind.
See… we’re already off to a great start.
Yes, your equipment is part of your allowable deductions, but there is something more to consider when deducting it.
When it comes to deducting equipment, there is something to consider called depreciation.
Depreciation is a cost recovery system. Meaning that it allows you to recover the cost of what you paid for an item over the course of a set time period.
For instance, if you purchased a piece of equipment for $100 and it was stated to have a recovery period of 5 years, then you would recover that $100 cost over a period of 5 years (6 really, but I’m not going to scare you with the details)
The rule that determines if your equipment must be depreciated is also simple. It states that if the item you purchase has a useful life of longer than 1 year it MUST be depreciated.
Note: this is for physical items only. Things that live in perpetuity on the internet don’t count.
However, there are some sections in the tax code, that allow us to deduct the full cost of an item in the first year so that we don’t have to wait and spread the deduction over a few tax returns. And just to satisfy your curiosity, they are called “bonus depreciation” and “§179”.
Please note, however, that §179 has a cap of $1,000,000 (like we’ll ever reach that amount). Any amount left over after that amount will have to be depreciated normally – or will it? Well, that’s when Bonus depreciation kicks in. Bonus depreciation is usually taken after the §179 deduction limit has been reached, offering you an additional 100% deduction on the balance for 2018.
Here is an example from Section179.org
They have a cool calculator by the way if you want to play around with the numbers.
So, when it comes to deducting your equipment, you have options – options that must weighed against your financial projections.
If you think you are going to continue to have high profits in future years… then you may want to consider allowing depreciation to do its thing and spread the deduction of some years so you will more to deduct in the future.
On the other hand, if you project that you will have high earnings in the first year or same year that you purchase your equipment, you can the use §179 to deduct the entire cost that same year.
Here’s a bonus tip:
Using the §179, you can choose any amount to deduct, up to the total cost, that you want to. Meaning that if you want to be a little cautious and “save some for later” you can.
Example: Let’s say you brought a new iMac for $5,000. Using the §179 you can deduct $2,500 in the first year and save the balance to deduct the rest of the years. Pretty cool right?
Ok let’s move on.
Word of caution on this one…
If you so choose to deduct this one, do so with caution.
Now I’m not trying to scare you out of taking this deduction, I am, however, telling you that if you do take this deduction that you must do so with precision.
This deduction won’t necessarily get you audited, but it is looked at the most by the IRS because of the amount of misunderstandings surrounding it that causes a lot of erroneous deductions to be taken.
But you don’t you worry at all… your favorite uncle/cousin has got you covered.
First and foremost there are two words that you must understand when it comes to the home office deduction and they are:
Regularly and Exclusive.
In order to use the home office deduction, you must and I mean must… use the area of the home that you are deducting BOTH regularly and exclusively.
So what does these words mean exactly?
Let me break it down for you…
Regularly means that the space designated as “business use” is use more than just occasionally. I’ll be honest with you, there is no specific definition that constitutes regular use, therefore, each case will be assessed based on the facts and circumstances.
Exclusively does have a specific definition. It means that there can be absolutely no personal activities taking place in that space – period. If any personal activities are found to have taken place in that space, your entire home office deduction will be disallowed.
Now that doesn’t mean that have to run outside the office every time a personal call comes in or you have to prohibit the kids from coming in to ask a question, just make sure that there is a clear distinction between personal use and business use. I would keep at the same activity level as if it were your corporate office.
Once you have determined that the space is used both regularly and exclusively, the next step is to determine what is called the business use percentage of the area used for business. This is figured by dividing the square footage of the home office or space by the total square footage of the entire home.
For example: let’s say that you have a home that is 1000 sq. ft and the area used for business is 120 sq. ft. The formula would be this: 120 ÷ 1000 = 12%. Therefore, we can deduct 12% of the total cost of the household expenses (rent, mortgage interest, property taxes, insurance, utilities, internet, etc).
Additionally, if there were any expenses that were incurred as a direct result of the home office space, like a repair made to a wall in the home office, a paint job in the home office only… that is considered to be a direct expense and is 100% deductible.
Alternatively, if you don’t feel like doing all the math, the IRS has what is called the Simplified Method.
With the Simplified Method, all you need to do is measure the square feet of the home office area and multiply the result by $5. The answer will be your deductible amount. There is a max limit when you use this method, however, and it is 300 sq. ft. or $1,500.
Using the same numbers from the above example it would look like this:
120 sq. ft x $5 = $600 deductible amount.
There are some other rules that may come into play when using this deduction, but they are beyond the scope of this post. If you which to read about them you can read the instructions for the form 8829 or enroll into the self-employed tax course. Hint: the tax course is funner!
Paying your quarterly estimated taxes will prevent you from having to pay additional penalties when you file your tax return.
Our tax system is a “pay as you go” system. That means that we are supposed to pay taxes on the amount that we earn, when we earn it.
As employees, our employers withhold and pay our tax obligations through what we know as withholding. But, as self-employed individuals, we are 100% responsible for paying our tax obligations ourselves. And if we fail to meet those obligations… the IRS and even the States imposes additional penalties.
The best way to avoid this is to pay what is called Quarterly Estimated Payments.
This is a really easy process to do as well. All you have to do is… every quarter, determine your “net” income (gross income – expenses), multiply it by 15.3% and voila` you have just determined the amount of taxes you have to pay. From there, all you have to do is pay it.
However, there are set deadlines to pay for each quarter and here there are:
There you have it.
The best ways to save money on your tax bill when you are an Online Entrepreneur.
Hope this helps and if there is anything that you thought of that I didn’t… please let me know.