If you are self-employed and working out of a home office, your tax filing requirements will be different than those of a company employee. Although the taxation scheme applicable to you offers advantages and disadvantages, creative business structuring can significantly reduce your tax burden.

Filing Requirements

If you are an unincorporated sole proprietor, you need not file any separate tax return for your business. Instead, you must file IRS Form 1040 and report your business's income as your individual income. You must also file Schedule C to report your business profits or losses. Finally, you will have to pay quarterly estimated taxes using IRS Form 1099.

Taxes and Deductions

The major disadvantage of being a sole proprietor (other than unlimited liability) is your obligation to pay self-employment tax--also known as the Social Security Tax--at the rate of 15.3 percent of your gross income. This obligation applies to all of your business income. While a corporation can retain its earnings and thereby shield shareholders from being taxed on these earnings, all of the income of a sole proprietorship will be treated as your personal income. A major advantage of working from home as a sole proprietor, however, is your right to deduct reasonable home office expenses from your taxable income on your From 1040 tax return. Be careful about documenting your expenses, because the IRS is prone to audit taxpayers who claim high home office expenses.

The S Corporation Tax Treatment Option

One way to minimize self-employment taxes is to form a one-member Limited Liability Company (LLC), file IRS form 8832 to elect corporate tax treatment, and then file IRS Form 2553 to be treated as an S corporation. S corporations are not taxed at the corporate level, but electing S corporation treatment will relieve you of the obligation to pay self-employment tax on your ownership share of company profits. Instead, you will be taxed at individual income tax rates on income that is actually distributed to you. Wages that you receive from the LLC will still be subject to a 15.3 percent self-employment tax. For this reason, it is advantageous to pay yourself a low salary and take high dividends as the owner of the company. Nevertheless, the IRS insists that you pay yourself "reasonable" compensation in order to prevent you from completely eliminating your payroll tax burden entirely using this strategy. If you select this option, you will have to file IRS Form 1120S on behalf of the LLC in addition to your Form 1040 individual income tax return, and the LLC will have to pay quarterly estimated taxes. Unlike standard corporations, which are taxed at higher corporate rates, S corporations are not taxed by the IRS on either income or dividends, although owners pay taxes on all S corporation profits at individual income tax rates.

Home-Based Corporate Employees

If you are employed by a corporation but work at home, you will be taxed the same as an office-based employee, except for the home office expense deduction. That means that you will not have to pay the 15.3 percent self-employment tax--instead, you will pay half that amount (7.65 percent) in Social Security taxes, and your employer will pay the other half. You will be responsible for filing only Form 1040 (there is no need to file Schedule C or Form 1099). If you work part of the time at home and part of the time in an office, you may take the home office expense deduction as long as the expenses that you deduct are actual and reasonable under the circumstances.

Source:

Business Owner's Toolkit: Home Office Deductions

Minnesota Attorney: Can an LLC Be Taxed as an S Corporation?

IRS: Sole Proprietorships

More Information:

IRS: Business Use of Your Home