Home-based Business

May is "Small Business Month" and it's always great to do business with other businesses as well as customers. Many times small business owners can be unclear about many expects of the administrative and legal processes that need to be considered when starting their business as well as during the time or operating it. I enjoy learning and broadening my knowledge of various subjects. I have physical, electronic, and audio libraries to prove it. 

Do you know...as far as the IRS is concerned, a home-based business is no different than any other business. Home business owners file business tax returns, report the earnings as business income, and deduct business expenses. The expenses that home-based businesses can deduct  are exactly the same as the expenses every other business can deduct, with one important exception: the home itself. 

If you use part of your home for business--your office, workshop, store, warehouse, or whatever you are using your home for--the cost of the space (the rent or, if you own your home, the depreciation) and some of the expenses directly related to the space, such as utilities and maintenance, can be deducted only if the space meets special IRS requirements. The two basic rules are (1) a principal place of business, and (2) regular and exclusive use.

• Rule #1: A principal place of business. Your home must meet at least one of the following four requirements.
  • 1. The home must be your principal place of business, defined by the IRS as "the most important, consequential, or influential location."
  • Or...2. The home must be used regularly (not just occasionally) by your customers or clients.
  • Or...3. The home must be used regularly to generate sales, such as making calls and preparing estimates.
  • Or...4. The home must be the sole fixed location where you conduct substantial administrative or management activities for the business: where you do your paperwork or your research, order supplies, or schedule appointments. You don't have to do all you administrative or management work at home, but it should be the main location for these activities.
• Rule #2: Regular and exclusive use. 
  • To be eligible for the home deduction, in addition to meeting Rule #1 above, a specific part of your home must be used regularly and exclusively for business. It can be a separate room or even part of a room, as long as it is used for the business and nothing else. PERIOD. No television in the office. No personal paperwork at the desk. (NO GAMES ON THE COMPUTER.) The business area can't double as a guest room, kid's room, or anything else, even when you are not working. 
  • There are two exceptions to the exclusive rule:
    • (1) If your home is your sole location for a retail sales business and if you regularly store your inventory or your samples in your home, the expense of maintaining the storage area is deductible even if it isn't exclusive use of the space. 
    • (2) If you operate a licensed day care facility in your home, you do not have to use the space exclusively for business.

These requirements are fairly simplistic and are very easy to meet for most home-based businesses. Still, lots of home businesses DO NOT TAKE THE DEDUCTION because of a widespread belief that deducting your home office or workspace is likely to lead to a TAX AUDIT, which is NOT TRUE! Actually, the IRS does not audit home-based businesses any more than other small businesses, at least not home businesses that report a profit. The IRS is more likely to audit a home business if the business has a loss, especially if the loss is offsetting other income and reducing income taxes. The IRS is also more likely to audit a home business, or any business for that matter, that takes large deductions for expenses like travel and entertainment, which are considered on of the "RED FLAG" deductions.
So the message is: "Don't worry about the IRS. Deduct everything you are entitled to."
There is one other tax deduction, in addition to the home expense deduction, that is limited for home-based businesses. The cost of a land-line telephone into the home CANNOT, in some cases, be deducted. It's a little law that's slowly becoming obsolete as more and more businesses are switching to cell phones, smartphones, and internet connections, which do not come under this land-line law. 

Other business use of the home: The Home Expenses deduction applies not just to businesses that are home based but also to any business where the owner of the business uses his or her home for business purposes. Many mobile businesses--businesses that travel to customers--quality for the home expenses deduction. Contractors, salespeople, entertainers, freelancers, consultants, and others who earn income outside the home may be eligible for the home expenses deduction. Even businesses that have separate business locations outside the home may be eligible for the deduction. All IRS rules for deducting home expenses are explained under the Home Expenses post next.