Budding entrepreneurs may not think of home-business tax deductions as the reason they're branching out on their own. But business owners who work out of their homes need to understand what expenses they can deduct, how to manage taxes from their home base, and avoid common mistakes when filing home-business taxes. If you don't, you risk losing out on money-saving deductions and, worse, face potential penalties for failing to comply with applicable federal and state regulations.
How to do your home-based business taxes
As a home-based business owner, you have to consider many tax rules. First, it’s important to keep detailed records of your income and expenses. Save all your receipts, making sure to note the purpose of each specific expense. You may have a mobile app or computer program to track your expenses, but you should still file copies of receipts to prove when money goes toward business needs.
You can improve your recordkeeping processes even more by utilizing an online accounting system. This approach has many advantages, including the ability to execute administrative tasks on the go, such as tracking expenses, sending invoices, and viewing bank balances.
In advance of filing your home-business taxes, consider opening a separate bank and credit card accounts specifically for your business. These will help you keep business costs separate from your personal charges. If you can't afford to pay the entire balance due, many business owners pay their personal cards first. Personal interest expenses cannot be deducted, but business interest is deductible.
Tax deductions for home businesses
When it comes time to file your home-based business taxes and submit claims, look into taking the home-office deduction, in which you can deduct expenses associated with business use of your home. Examples of home-business tax deductions include:
- Homeowners/renters insurance
- Homeowner association fees
- Cleaning services and office supplies used in the business space
- Mortgage insurance and interest (homeowners)/part of rent (renters)
- Utilities such as internet, heat, electricity, and phone
- Security systems
If you use your own vehicle for work purposes, a portion of your transportation expenses can be deducted against your business income. In addition, homeowners can deduct a portion of real estate taxes and claim asset depreciation. In the case of a fire, theft, or damage from a storm, a portion of the loss can also be considered a business expense.
Your total home-office deductions are limited by your business net income, i.e., they can't cause a business loss. However, excess deductions can be carried forward to the next year and claimed then.
When taking advantage of the tax benefits of a home-based business, make sure to avoid the common pitfalls of small business owners, such as inaccurate returns, missing payment deadlines, or making deduction mistakes — any of which could potentially result in fines. To ensure compliance with home business tax laws, it's often a good idea to consult with a professional tax service or certified public accountant. This investment may save you time, help reduce the risk of fines, and give your home-based business a strong foundation for future growth.
Who qualifies for home-business tax deductions?
There are several requirements to claim the deduction — visit the IRS website to see if your business qualifies.
The "exclusive rule" means that the claimed space must be used entirely for business, not a blend of personal and business. A portion of a space may be used, such as part of a basement or garage. “Regular use” means that business-related tasks are performed there on a regular basis. In some cases, a business owner may have another office elsewhere, but if the home office is used frequently, then home-business tax deductions are allowed.
Most types of businesses qualify for home-based business tax deductions if a portion of the home is used on an exclusive and regular basis. Examples of qualifying business purposes include:
- Meeting with clients
- Repairing equipment
- Performing administrative tasks
- Storage of inventory, parts, materials, and tools
Administrative use is the broadest definition and can benefit many businesses, especially those who perform a service or sell products at customer locations but do their bookkeeping at home.
How to calculate your home office deduction
There are two methods: standard and simplified. You can switch year to year between the standard and simplified methods, depending on what works for you.
The standard method requires you to measure the square footage of the area used for business. You will then divide that amount by the total square footage of the home to arrive at a percentage. Actual expenses are used for the standard method, so that means saving your bills and adding them up at the end of the year. You then apply the business percentage to figure out how much you can deduct.
The simplified method involves multiplying the square footage by a set rate to determine the deduction. However, the square footage is limited to 300 square feet, so the maximum deduction is $1,500. This may work well for businesses with small offices, but those who use a lot of space or have multiple businesses or purposes could benefit from the standard method.
The IRS offers detailed information about home-business tax deductions and how to calculate them.
Small business tax considerations
Detailed accounts are extremely useful if your home business faces a possible tax audit. Maintain a daily log of home-business activities, attaching receipts to the log or scanning the receipts digitally. Transferring your daily reports into a monthly tracking sheet can make getting your home business taxes together much quicker and easier. Plus, it has the added benefit of giving you another way to monitor business activities over time.
The U.S. Chamber of Commerce offers these additional tips:
- Keep your business and personal expenses separate. To most effectively assess your business income and expenses, it's imperative to maintain separate accounts for business and personal finances.
- Are personal assets such as a laptop, smartphone, or car used for both business and personal reasons? If so, maintain a record of all business use to have an accurate calculation of the percentage that's business-related.
More information on home-business tax laws can be found on the IRS website.