Home-Based Business Tax Deductions

IRS Home Office Requirements

Two crucial IRS requirements exist with regards to claiming home-based business tax deductions. A 'home office' must meet the IRS definition, which states that the workspace is regularly and exclusively utilized for business.

Regular Use of Workspace

The first of the two IRS requirements for home-based business tax deductions is relatively easy to meet. The IRS has no definitive guideline on "regular" use, and part-time work is sufficient. Generally, a minimum number of hours matters less than consistency, say, at least weekly. If your work is very minimal or sporadic, verify that your business isn't considered a hobby under IRS rules.

Exclusive Work Area

The second part of the IRS requirement, exclusivity of workspace, is quite strict in definition. Foremost, the area defined as a 'home office' must be designated only for work use. Technically, if not legally, speaking, you should not so much as use your work desk to pay a non-work related bill. However, exemptions to this rule exist for daycare businesses and storage-related workspace, both allowing shared areas.

Do You Qualify?

Bottom-line: If you have a separate room absent of non-work related items, such as a bed and TV, and live alone, the home office deduction is rather straightforward. If your workspace is a partial area, deductions become more complicated. Mixed-living areas, such as the kitchen table, will not qualify as a home office, while partitioning off an area in the den may.

Further, if school-age children reside in the home and only one computer is available in the household, which you claim, can you reasonably assert the children do not use the 'business computer' for homework? The burden of proof is upon you, the home business owner. Your best recourse is documentation aided, if in doubt, by a tax advisor.

Home Business Documentation

Though you should not fear claiming home-based business tax deductions, the burden of proof is something to take into account. Otherwise, proper record-keeping will help you stay on solid ground with the IRS. Implement the following procedures to establish your home business as a viable tax deduction:

• Take pictures of the workspace and store them with tax records.
• Make a diagram of the home office in proportion to the home.
• Record all business-related visits to the home / home office.
• Use your home address for business mail and promotional material.
• If applicable, acquire a separate phone line for the business.

Available Home-Based Business Tax Deductions

Several tax savings exist for the self-employed, but documenting deductions is somewhat tedious. Find an efficient accounting system that you will implement judiciously.

Home-Related Expenses

Deducting a portion of your housing expense often involves measuring the workspace square footage and dividing by the square footage of livable space in your home. An easier option, if room size is relatively equal, is to divide the number rooms used for business by the total rooms. For instance, one work room out of five household rooms equals 20 percent. Either method results in the proportion of the expenses that may be deducted. Qualifying home-based business tax deductions include:

• Mortgage/rent
• Utilities (besides basic home phone service)
• Insurance (homeowners/rental)
• Repair and maintenance
• Phone: itemized business calls only, unless a separate line is used

Common Deductions

Claiming a home office deduction is not a pre-requisite for other business-related tax deductions. Products and services reasonably used for business operations should qualify, though restrictions and depreciation values vary. Ensure that you keep abreast of tax law changes. For instance, mileage reimbursement can vary over the course of a year and technological changes affect tax law. Computer software is now 100 percent deductible the year it's purchased. Formerly, its value depreciated over three years. Common home-based business tax deductions include:

• Office supplies
• Furniture
• Equipment
• Computer software
• Automobile/mileage
• Business fees and licenses
• Business-related education (e.g. seminars, classes)
• Business-related expenses
• Subscriptions and publications (e.g. Internet service, periodicals)
• Fees paid to professionals (e.g. accountants)

Health Insurance, Social Security and Retirement

One disadvantage to self-employment, health insurance premiums, now becomes a tax advantage. Health insurance premiums are 100 percent deductible unless you qualify elsewhere, such as through your spouse's employer. As for Social Security and Medicare tax, as a sole proprietor you are paying double the rate, compensating as an employer. Half of this amount, from your 1040 tax form, is deductible. Lastly, you can benefit from retirement investments. Contributions made to retirement plans, such as a SEP-IRA or Keogh, are fully deductible.

Final Requirement: Profits

Finally, to qualify for home-based business tax deductions, the deductions cannot exceed your company profits; otherwise the amounts will be reduced or eliminated. Further, to avoid classification as a hobby, or be red-flagged as a tax loophole, a consistent effort to generate a profit needs to be shown. Put simply, a profit is not required, but some tangible evidence of attempts to generate revenue is, such as advertising expenditures and a work log.

More Business Tax Information

The IRS Web site provides online forms, publications and articles on self-employment and home-based business deductions. Additionally, several self-help books exist, such as Home Business Tax Deductions: Keep What You Earn, by Stephen Fisherman.