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No need to fear, the path to home will soon be clear. And yes, the rumors are true - you can take a deduction for your home office and your vehicle too!!
But, just when you think you’re nearly there, more confusing words start to appear. They’re coming right at you and piling high. You see Gross Receipts, Gross Income, and Gross Profits. Oh why?!
As you venture on your journey through the land of SE (SE means self-employment, in case you didn’t guess), there may be terminology that you don’t quite understand. And if you do, it’s possible the IRS defines it just a little bit differently than what you’re familiar with.
Let’s clarify the meanings for common terms every self-employed person needs to know:
- Gross Receipts (aka Gross Sales) - Think of this as every dollar (or item of value) your business takes in from the products and services it sells. Yes, it’s as simple as that!
Gross receipts could be in the form of cash, checks, credit cards, cryptocurrency or even barter income. (For barter income, you include the value of the item or service you receive in exchange for your own merchandise or services.)
You might also receive tax forms (1099-NEC, 1099-MISC, and/or 1099-K). Those need to be included as well, but be sure to not duplicate the income when reconciling your bookkeeping with the forms entered into TurboTax for tax preparation. - Gross Profit - This is what’s left over after you subtract COGS (Cost of Goods Sold), refunds, or (after the sale) price adjustments provided to your customers or clientele.
- Gross Income - After you’ve figured out your Gross Profit, there may be other miscellaneous income that isn’t really related to sales (or normal course of business activities). The additional income could be from sources such as receiving a prize or award, bad debts that the business later recovered, or other (mostly uncommon) income. The end result is your true Gross Income.
- Net profit - This is the ever-so-important taxable amount. It’s the dollar amount after you’ve deducted all of your business expenses. Each type of business may have some unique deductions available, but the general rule is that you can deduct any “ordinary and necessary” business expenses. Of course you need receipts to back up those deductions - that’s part of recordkeeping/bookkeeping and a whole other topic of discussion.
- COGS (Cost of Goods Sold) - This one gets confusing because everyone knows there’s a “cost” to everything that is sold. However, it’s really about inventory or manufacturing costs. If you produce your own products to sell or purchase items at wholesale prices for resale, you will have COGS. Think of the costs that are included in COGS, as labor and materials to manufacture or obtain physical items.
Service industries generally don’t have COGS because there is no physical inventory/product that is sold. - At Risk - If you are a self-employed sole proprietor, who’s had a loss on their business, you may have noticed a question asking if “All investment is at risk” or if “Some investment is at risk”. The easiest way to explain this is if the only money or property put into the business is from your own personal sources, it is “all” at risk. If all of the investment into the business is not at risk, your loss deduction may be eliminated or reduced.
- Self-Employment Tax (SE tax) - Surprise! There’s a special “additional” tax on your net profits! That’s right, you will pay an additional 15.3% on any amount over $400 in addition to your Ordinary Income tax rates. To be fair, you do get a deduction for half of the amount you pay. And the reason for it is to cover Medicare and Social Security that you’d normally have deducted from W-2 income, if you were a regular employee elsewhere. This article What is the self-employment tax? has more details about SE taxes.
- Quarterly Estimated Taxes - The IRS and state taxing authorities tend to want their income taxes as you earn the income. Thus, the creation of quarterly estimated income taxes. As a self-employed person, you don’t receive that paycheck with taxes withheld and sent in on your behalf. It’s completely up to you to make sure those tax payments are made. TurboTax will help you figure yours out. In the meantime, here’s A Guide to Paying Quarterly Taxes that will really help!
- QBI (Qualified Business Income) - This is a good one! How would you like a 20% deduction off of your Adjusted Gross Income - just for having a profitable business? Pretty nice concept, right?! Most smaller businesses that have a net profit can get a deduction on some or all of that profit. How it works is a little complex so it might be easier to simply check out the TurboTax article that answers the question of What is the Qualified Business Income (QBI) deduction?.
- Depreciation - Assets are treated the same whether you’re working a side gig or have a larger full-time business. When you make a large purchase for your business such as equipment or furniture, those are considered assets. The IRS has several ways for you to claim those high-dollar purchases and the most common method is by depreciation. What is depreciation anyway? Depreciation is a method of “writing off” only a portion of that asset each year so you can benefit from the deduction as your income increases year-after-year.
We’re almost at the end of the road, and there are two favorite deductions - or so I am told! So to save you some work, I’ll share the following self-employed perk!
Your home and car could save you taxes!
If you have a bonafide home office, you can deduct that part of your home as well as related expenses such as utilities, HOA fees, mortgage interest, homeowners insurance, and more! One requirement is “exclusive and regular use” of the home office space. Read more about claiming the home office deduction to see if yours qualifies.
And possibly even better than that might be the vehicle deduction. This one can be huge if you drive a lot in the course of doing business. Check out the details about the Business Use of Vehicles to see if you can save some taxes there too!
Of course, there’s always more to share. Here are a few resources so you’re more aware.
What is a Schedule C IRS Form?
Am I considered self-employed?
Self-Employment Taxes in Today's Gig Economy
When the IRS Classifies Your Business as a Hobby