Working at Home

Don’t listen to the naysayers who tell you that taking the home office deduction is a red flag for an IRS audit. Congress created these tax breaks and we’ll show you how to take advantage of them.

Hard to believe, but you can get a tax break for staying in your pajamas and fuzzy bunny slippers to run your business.

Many people who leave jobs—either voluntarily or following a lay-off—choose to start their own business and work out of their homes. Once you switch from life as an employee to become an independent contractor, your tax situation also changes. Here are several things you can do to keep your tax house in order:

Your employer used to take care of withholding your income taxes and sending payments to the IRS. But once you're self-employed, it'll be up to you to make estimated tax payments to the IRS during the year to cover your federal tax liability, unless you expect to owe less than $1,000. You make your payments quarterly, using Form 1040 ES.

Uncle Sam takes a bigger bite out of your income, employment-tax wise, when you’re on your own. To cover your Social Security and Medicare taxes, in 2012 you'll owe Uncle Sam 13.3 percent on the first $110,100 of your net earnings from self-employment.

For net earnings above $110,100, you'll owe Medicare tax of 2.9 percent.

But there's good news: You can deduct half of your self-employment taxes when figuring adjusted gross income on your 1040. So if you're in the 25 percent federal income tax bracket, the government effectively refunds 12.5 percent of the Social Security tax you pay.

Don’t throw away those receipts!

You can write off a long list of business costs—everything from business meals to insurance to bad debts—so it's important to maintain good records of those expenses to get all the tax deductions you're entitled to. And because you can't deduct personal expenses, you must be sure to keep your business expenses separate. An easy way to do this is to set up a separate bank account for your business, and have a credit card you use only for business purchases.

If you're working from home, deducting the costs associated with your home office can be a big tax saver—but the rules are tricky.

To get the deduction, the law requires you to use your home office "exclusively and regularly" for your business. It must be an area in your home where you don't mix business with other activities. In other words, the kids can’t play and you can’t watch a lot of football in the same area as your workplace. So put that big-screen TV somewhere else in the house.

The office also has to be your principal place of business or a place you meet regularly with clients or patients. What if you’re on the road a lot for business? No problem. You can qualify even if you spend most of your work time away from the office—such as a self-employed plumber who spends most of his time working at clients' homes—as long as you conduct administrative and management activities in your home office and don't use any other fixed location to do those activities. If you qualify for home office deductions, the write-offs will help pay for what would otherwise be considered personal expenses, such as part of the cost of utilities and homeowner's insurance premiums.

Working in your pajamas is still work.

So plan now for full-time relaxation later and start a retirement plan, which is another great tax saver. And once you're self-employed, your options go far beyond an individual retirement account. Check out an SEP (Simplified Employee Pension), SIMPLE (Savings Incentive Match Plan), and Keogh as well as individual 401(k) plans. All allow you to sock away money for retirement and take a tax deduction for what you contribute.

TurboTax Home & Business offers step-by-step guidance for preparing your personal and home business taxes, so you get every deduction you deserve.