TAXES > Individuals > Gross Income > Business and Freelance (Schedule C)

Schedule C - Self-Employment Income

Income or loss from a business or profession is reported on Schedule C. Earnings are generally reported on Form 1099-MISC but are taxable even if the payor fails to file the proper forms. The IRS maintains the right to audit bank statements for deposit information in the case of a self-employed individual. The taxpayer may deduct expenses incurred in the course of earning the income in the same manner that an employee deducts business expenses and the net income (or loss) is transferred to Form 1040, line 12. For the purposes of computing Social Security self-employment tax (Schedule SE), the net income is reduced by 7.65% and then multiplied by 12.4% for Social Security and 2.9% for Medicare. Social Security is payable on earned income to a maximum of $97,500 (which generally increases every year) and there is no limit on Medicare. Any wages subject to Social Security and Medicare separate from self-employment earnings are included in calculating the maximum. Note that if taxable income after the 7.65% reduction is less than $400, Schedule SE does not apply.

A loss on Schedule C is deductible on Form 1040, line 12 to the extent the taxpayer is "at risk." Taxpayers should be wary of continuing losses in consecutive tax years - there must be a bona fide purpose for the self-employment, not simply a hobby or other activity designed to generate a loss for tax purposes.

Home office expenses are available to self-employed individuals under certain circumstances. These expenses include a portion of rent and utilities attributable to the business use, i.e. ratio of business space to total area of home using square footage. The home office deduction is reported on Form 8829 and may only be deducted to the extent it does not create a loss on Schedule C. The portion of the home used for business must be separate (a room or structure, not a corner or area), and exclusive (no other activity takes place there, no bed, television, or other personal purpose). Under the Supreme Court's "Soliman" decision, an analysis of the relative importance of the activities performed at each location and the time spent at each place (i.e., time spent at the home vs. time spent elsewhere). For example, an analyst who treats all patiens in the spare bedroom of an apartment qualifies for the deduction, but a sales person who spends most of the time selling on the road does not, even though necessary paperwork and phonecalls take place at the home. In 1998, however, the rules were eased and currently a taxpayer may take the home office deduction if the home is used for the administrative or management activities of the business (but only if there is no other fixed location where the taxpayer conducts substantial administrative or management activities), or if by comparative analysis it is proven that substantially all of the activity of that business is performed in the home. Thus, a journalist may now take the home office deduction if all of the writing takes place in the home, but not if most of the research for that writing is compiled during travel. A professional may deduct home office expenses if the home is used to meet regularly and exclusively to meet with clients, patients, or customers in the normal course of business. Telephone conversations do not suffice; clients must be physically present for deductions to be claimed under this rule. Therefore, starting in 1998, many individuals who could not avail themselves of this benefit are now permitted, including performing artists who use a separate room at home as a rehearsal studio on a regular basis.

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