TAX GUIDELINES FOR HOME-BASED SMALL BUSINESSES

If you’re an entrepreneur who operates solely from a home office, you can take advantage of home-based business tax deductions.

In addition to your operational expenses, you may be eligible for a home office deduction. The incentive benefits self-employed taxpayers who dedicate part of their home to running their business.

Keep reading to learn about tax breaks you can take to reduce your home-based business tax liability.

What Is a Home-Based Business?

A home-based business owner operates primarily from an office at their home. The IRS offers tax advantages to individuals who dedicate a portion of their living space to their business. Both homeowners and renters may take a home office tax deduction.

Remote and hybrid employees are not eligible for home-based business tax incentives. You must be a sole proprietor – not an employee – to take the home office deduction.

Further, your home office must follow IRS eligibility rules. Publication 587, Business Use of Your Home, explains the following:

• The “exclusive use” test requires you to use part of your home only for your business. For example, you can designate your den as an office, where you use the space solely for business purposes. A dining room table where you host family dinners could not qualify.
• The “regular use” test requires that you frequently use the dedicated office space to operate your business. Periodic use, such as once each week, does not suffice.
• The “principal place of business” test requires your home office to be the primary place you operate your business. For example, your home is the only established place where you conduct client calls and complete administrative responsibilities.

How Does My Home Qualify for Business Tax Purposes?

The IRS outlines several types of living spaces as eligible for home-based business tax expense deductions.

Your business can establish a home office in a house, apartment, condo, mobile home, or boat. If you own or rent a property with a detached garage or studio, the separate structure may qualify. Additionally, space dedicated to a daycare facility meets the home office definition. However, if you rent your house to overnight guests, the rental space cannot qualify as an office.

If you and your spouse or roommate operate separate businesses from home, you can each take home-based business tax deductions, but you cannot take tax incentives for the same space. For example, if two people share a dedicated office, only one person may take a tax benefit for the room.

Consult with tax professionals to determine whether your LLC or sole proprietorship qualifies for a home-based business tax incentive.

Small Business Tax Deductions for Home Businesses

What can home-based businesses claim as tax-deductible expenses?

Your small business can deduct day-to-day expenses in addition to your home office costs.

Self-Employed Business Deductions

Aside from the home office deduction, you can deduct your operational costs. For example, your small business may incur managerial and professional service fees.

Freelancers and independent contractors can deduct the following costs, regardless of their eligibility for a home office deduction. Review your spending to identify deductions you might have missed.

Operating Expenses

Operating expenses include the day-to-day costs you incur while running your business, generally including the following:

• Employee salaries and wages
• Cost of goods sold
• Supplies and equipment
• Software

Travel Expenses

Consider your travel for business-related meetings and events. Travel expenses may include the following:

• Mileage
• Airfare and lodging
• Transportation services

Business Insurance

Your company can deduct premiums for insurance policies such as the following:

• Employee medical and retirement plans
• Liability or malpractice
• Workers’ compensation

Depreciation

Taxpayers must depreciate large equipment over the asset’s useful life. For example, office furniture is depreciated over several years instead of generating a full deduction during the purchase year.

Deduct your business depreciation expense on your annual federal tax return.

Miscellaneous Expenses

IRS Publication 535, Business Expenses, details numerous costs that may qualify as tax deductions. Consider whether your company incurs the following:

• Advertising and marketing expenses
• Industry-related training costs
• Business loan interest
• Legal and professional fees

Review the IRS guidance for a list of costs you can deduct and schedule a free consultation with SHACO to maximize your tax write-offs.

Home Office Deduction

To write off the business use of your home, consider expenses such as real estate taxes, mortgage interest, rent, utilities, insurance premiums, maintenance, and repairs.

The IRS allows two options for calculating the deduction. Taxpayers can choose the regular method or the simplified method.

Home Office Deduction – Regular Method

The regular method follows two steps.

Step 1: Total your home costs, such as your utilities, insurance, mortgage interest, or rent for the year.

The following indirect costs are eligible for allocation to your home office:

Home expenses (also considered itemized deductions on Form 1040, Schedule A):

• Home mortgage interest
• Real estate taxes

Business-related expenses (otherwise nondeductible on your tax return):

• Home depreciation
• Homeowners Insurance
• Rent
• Repairs and maintenance
• Utilities

Step 2: Allocate your indirect home costs to your office space.

Your allocation depends on the ratio of your office to your total living area. Divide the square footage of your office by the total square footage of your home (including your office).

Multiply the result by your indirect expenses from the business use of your home (from Step 1). The product represents your home office deduction.

For example, imagine your home office occupies 100 square feet of your 2,500 square foot house. If your indirect costs totaled $5,000 for the year, your home office deduction would be $200: 100 SQ FT / 2,500 SQ FT x $5,000 = $200.

Home Office Deduction – Simplified Method

The simplified option allows taxpayers to avoid complex calculations. The simplified home office deduction represents $5 per square foot of the business owner’s home office. The deduction limit is 300 square feet, or $1,500.

If you use the simplified method, you cannot deduct indirect expenses such as rent, repairs, and home depreciation. (Homeowners can still take itemized deductions for mortgage interest and real estate taxes.)

Which method maximizes your deduction? Tax professionals can help you determine whether to use the regular or simplified calculation.

Home Office Expenses You Can’t Write Off

Certain home office costs are nondeductible, regardless of the calculation method.

Personal expenses you incur for non-business activities cannot generate tax incentives. For example, decorating your office or remodeling a bathroom represents an unrelated expense. Fines and penalties are also nondeductible for tax purposes.

Additionally, you must not deduct home office expenses exceeding your business income for the tax year. For example, if your home-based business generated $300 of net income before the home office deduction, your limitation would be $300.

How to Claim the Home Office Deduction

Home-based small business owners can claim tax benefits by attaching relevant schedules to IRS Form 1040, U.S. Individual Income Tax Return.

Sole proprietors should complete IRS Form 1040 Schedule C, Profit or Loss from Business, to report income and expenses. You can list the simplified home office deduction on Schedule C.

If you opt for the regular method, use IRS Form 8829, Expenses for Business Use of Your Home, to report your home office deduction calculation. The Form 8829 instructions provide helpful guidance for classifying your expenses and calculating inputs.

Homeowners should use IRS Form 1040 Schedule A to report itemized deductions such as home mortgage interest.

Recordkeeping Requirements

Maintain thorough records supporting your deduction. In case of an audit, you should be ready to provide documentation detailing the following:

• The portion of your home you use exclusively to operate your business
• The indirect expenses allocated to your home office
• Your rent or mortgage interest expense and real estate taxes for the year
• Depreciation expense calculations, including the purchase price of your home

Additionally, you should maintain comprehensive bookkeeping records to support your business income and expenses.

The IRS requires taxpayers to keep records for the latest of the following: (i) two years after the tax was paid; (ii) three years after the return filing; or (iii) three years after the return due date.

Get Personalized Help and Maximize Your Small Business Expenses

The IRS imposes stringent rules on the home office deduction, but complex calculations shouldn’t keep you from running your business. You can benefit from home-based business tax advantages.

SHACO can support your tax reporting year-round. Tax and accounting experts offer guidance on complex rules and calculations.

Small business professionals can help you maximize your home office deduction. Schedule a free call with SHACO to learn how our tax advisory services can lower your tax bill.

This post is to be used for informational purposes only and does not constitute legal, business, or tax advice. Each person should consult his or her own attorney, business advisor, or tax advisor with respect to matters referenced in this post. SHACO assumes no liability for actions taken in reliance upon the information contained herein.