Self-employment is one of the best tax strategies to have, apart from being an investor or owning rental property. All three have the advantage of allowing you to be in full control of your tax situation and allowing you to claim any losses incurred through your business.
However, the IRS is more than aware of the benefits of claiming self-employment status, and are on the lookout for individuals who claim a high salary but large business losses, and for those who report a business loss for consecutive years.
Most of the self-employed are considered "sole proprietors," and need to be sure to report their income and expenses on schedule C of the 1040 tax form. It is important to separate your income earned as a sole proprietor from any other income you may acquire. If your clients send you a 1099-MISC form that reports the total payments they sent you for the previous year, you must be sure that the total income you report on line 1 of Schedule C is equal to or greater than the total of all the 1099-MISC forms you receive. Otherwise, the IRS will likely audit your business. The best way to avoid auditing is to report all your income.
When it comes to expenses, it is recommended to track all business-related expenses in the same categories as are listed on the Schedule C form. Acceptable and common deductible expenses include: advertising, insurance, interest on credit cards or loans, legal and professional services, office expenses, rent paid on your office space, repairs and maintenance related to your business, supplies, travel, related meals and entertainment, utilities and any other expenses directly related to your business.
Although you are allowed to claim expenses on an office in your home, you cannot use those expenses to create a loss on your business. In other words, you must claim at least $0 or above in income if you're including any home office expenses. When claiming a home office, however, keep in mind that you can only claim utilities and expenses on the actual space the home office takes up.
If you end up with a profit for your business, (income minus expenses equals profit), you must pay a self-employment tax. This is calculated on form 1040 Schedule SE and is 15.3% of your net profit. This amount is equal to the amount of social security and Medicare taxes owed on your business income.