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Tax tips for the home based business

Patti Reece, E.A. 970-260-4839
Patti Reece, E.A. 970-260-4839

This document discusses the tax benefits of operating a home-based business. Key points include being able to deduct home and vehicle expenses, as well as travel costs, as long as they are ordinary and necessary to running the business. Proper recordkeeping of mileage, expenses and time spent on business activities is important. Deductions are allowed for a home office, advertising, gifts, and paying family members as employees. With good documentation, a home-based business can enjoy substantial tax savings.

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By Patti Reece Enrolled Agent
Benefits of Home Based Business You are able to deduct expenses that you incur anyway such as home expenses. Everyone we talk to are potential clients. Expenses related to securing that client are deductible. Since our businesses are not limited to one area, travel is deductible as long as the main purpose is business. You save not only income tax, but self-employment tax on every deduction you are able to take.
Expenses Expenses must be "ordinary and necessary" in relation to a legitimate business activity, and satisfy all other requirements in order to be deductible business expenses on a tax return.
Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.
Business Use of Your Car If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. You generally can use one of the two following methods to figure your deductible expenses. Standard mileage rate. Actual car expenses.
Standard Mileage Rate Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use either the standard mileage rate or actual expenses. The standard mileage rate includes all expenses except finance charges. This is reported separately at the business percentage of use.
Actual Car Expenses If you do not use the standard mileage rate, you may be able to deduct your actual car expenses. If you qualify to use both methods, you may want to figure your deduction both ways to see which gives you a larger deduction. Actual car expenses include: Depreciation Licenses, Lease payments,Registration fees, Gas, Insurance, Repairs, Oil, Garage Rent, Tires Tolls, Parking fees
Keep a mileage log The IRS requires that you keep a mileage log. This log shows the miles driven and the business purpose At tax time, you will need: 1. The total miles driven 2. The number of business miles 3. The number of commuting miles (if you use the car for a job. 4. The balance would be personal miles.
Advertising display on car. If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expense based on the miles driven for each purpose.
Home Office Deduction: Basic Requirements In order to claim a deduction for that part of a home used for business, taxpayers must use that part of the home: Exclusively and regularly as their principal place of business, as a place to meet or deal with patients, clients or customers in the normal course of their business, or in connection with their trade or business where there is a separate structure not attached to the home; or On a regular basis for certain storage use such as inventory or product samples, as rental property, or as a home daycare facility.
Office in Home Deductions Expenses include: mortgage interest or rent, real estate taxes, insurance, repairs and maintenance, utilities, depreciation and casualty losses. The expenses are pro-rated depending on the percentage of use calculated. Expenses directly related to the office are 100% expensed Deductions are limited to the profit on the business except mortgage interest and taxes. Other expenses are carried over to the next year and used if a profit is shown.
Computing the Amount of Home Office Deduction Generally, the amount of the deduction depends on the percentage of the home that is used for business. The deduction will be limited if gross income from the business is less than the total business expenses. A taxpayer can use any reasonable method to compute business percentage, but the most common methods are to: Divide the area of the home used for business by the total area of the home, or Divide the number of rooms used for business by the total number of rooms in the home if all rooms in the home are about the same size.
Travel and Meals Taxpayers who travel away from home on business may deduct related expenses, including the cost of reaching their destination, the cost of lodging and meals and other ordinary and necessary expenses. The actual cost of meals and incidental expenses may be deducted or the taxpayer may use a standard meal allowance and reduced recordkeeping requirements. Regardless of the method used, meal deductions are generally limited to 50 percent as stated earlier. Only actual costs for lodging may be claimed as an expense and receipts must be kept for documentation. Expenses must be reasonable and appropriate; deductions for extravagant expenses are not allowable
Entertainment Expenses for entertaining clients, customers or employees may be deducted if they are both ordinary and necessary and meet one of the following tests: Directly-related test: The main purpose of the entertainment activity is the conduct of business, business was actually conducted during the activity and the taxpayer had more than a general expectation of getting income or some other specific business benefit at some future time. Associated test: The entertainment was associated with the active conduct of the taxpayers trade or business and occurred directly before or after a substantial business discussion.
Gifts Taxpayers may deduct some or all of the cost of gifts given in the course of their trade or business. In general, the deduction is limited to $25 for gifts given directly or indirectly to any one person during the tax year. If you give away products as promotions, be sure to keep track of those separately. They can be advertising or promotions. Items under $4 are not limited.
Recordkeeping You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records. Your recordkeeping system should also include a summary of your business transactions. Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books.
How long should I keep records? The length of time you should keep a document depends on the action, expense, or event the document records. Call your tax professional for details, but the general rule of thumb is 4 years. There are many exceptions to this rule!
Family Employees Hire your responsible teenage son to keep inventory for your business or answer the phone. This results in an additional business expense deduction for you, as well as income for your child. Be sure to document all the hours worked by family members (or any employee you hire) in case you are ever audited.
In conclusion: By having a home-based business you can enjoy substantial tax deductions. Keep excellent records. I find those that wait until the end of the year miss many expenses. A home-based business also is more productive as you do not have commute times etc. It is much easier to attract business builders due to the low overhead and startup costs.

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Tax tips for the home based business

  • 2. Benefits of Home Based Business You are able to deduct expenses that you incur anyway such as home expenses. Everyone we talk to are potential clients. Expenses related to securing that client are deductible. Since our businesses are not limited to one area, travel is deductible as long as the main purpose is business. You save not only income tax, but self-employment tax on every deduction you are able to take.
  • 3. Expenses Expenses must be "ordinary and necessary" in relation to a legitimate business activity, and satisfy all other requirements in order to be deductible business expenses on a tax return.
  • 4. Personal versus Business Expenses Generally, you cannot deduct personal, living, or family expenses. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.
  • 5. Business Use of Your Car If you use your car in your business, you can deduct car expenses. If you use your car for both business and personal purposes, you must divide your expenses based on actual mileage. You generally can use one of the two following methods to figure your deductible expenses. Standard mileage rate. Actual car expenses.
  • 6. Standard Mileage Rate Choosing the standard mileage rate. If you want to use the standard mileage rate for a car you own, you must choose to use it in the first year the car is available for use in your business. Then in later years, you can choose to use either the standard mileage rate or actual expenses. The standard mileage rate includes all expenses except finance charges. This is reported separately at the business percentage of use.
  • 7. Actual Car Expenses If you do not use the standard mileage rate, you may be able to deduct your actual car expenses. If you qualify to use both methods, you may want to figure your deduction both ways to see which gives you a larger deduction. Actual car expenses include: Depreciation Licenses, Lease payments,Registration fees, Gas, Insurance, Repairs, Oil, Garage Rent, Tires Tolls, Parking fees
  • 8. Keep a mileage log The IRS requires that you keep a mileage log. This log shows the miles driven and the business purpose At tax time, you will need: 1. The total miles driven 2. The number of business miles 3. The number of commuting miles (if you use the car for a job. 4. The balance would be personal miles.
  • 9. Advertising display on car. If you use your car for both business and personal purposes, you must divide your expenses between business and personal use. You can divide your expense based on the miles driven for each purpose.
  • 10. Home Office Deduction: Basic Requirements In order to claim a deduction for that part of a home used for business, taxpayers must use that part of the home: Exclusively and regularly as their principal place of business, as a place to meet or deal with patients, clients or customers in the normal course of their business, or in connection with their trade or business where there is a separate structure not attached to the home; or On a regular basis for certain storage use such as inventory or product samples, as rental property, or as a home daycare facility.
  • 11. Office in Home Deductions Expenses include: mortgage interest or rent, real estate taxes, insurance, repairs and maintenance, utilities, depreciation and casualty losses. The expenses are pro-rated depending on the percentage of use calculated. Expenses directly related to the office are 100% expensed Deductions are limited to the profit on the business except mortgage interest and taxes. Other expenses are carried over to the next year and used if a profit is shown.
  • 12. Computing the Amount of Home Office Deduction Generally, the amount of the deduction depends on the percentage of the home that is used for business. The deduction will be limited if gross income from the business is less than the total business expenses. A taxpayer can use any reasonable method to compute business percentage, but the most common methods are to: Divide the area of the home used for business by the total area of the home, or Divide the number of rooms used for business by the total number of rooms in the home if all rooms in the home are about the same size.
  • 13. Travel and Meals Taxpayers who travel away from home on business may deduct related expenses, including the cost of reaching their destination, the cost of lodging and meals and other ordinary and necessary expenses. The actual cost of meals and incidental expenses may be deducted or the taxpayer may use a standard meal allowance and reduced recordkeeping requirements. Regardless of the method used, meal deductions are generally limited to 50 percent as stated earlier. Only actual costs for lodging may be claimed as an expense and receipts must be kept for documentation. Expenses must be reasonable and appropriate; deductions for extravagant expenses are not allowable
  • 14. Entertainment Expenses for entertaining clients, customers or employees may be deducted if they are both ordinary and necessary and meet one of the following tests: Directly-related test: The main purpose of the entertainment activity is the conduct of business, business was actually conducted during the activity and the taxpayer had more than a general expectation of getting income or some other specific business benefit at some future time. Associated test: The entertainment was associated with the active conduct of the taxpayers trade or business and occurred directly before or after a substantial business discussion.
  • 15. Gifts Taxpayers may deduct some or all of the cost of gifts given in the course of their trade or business. In general, the deduction is limited to $25 for gifts given directly or indirectly to any one person during the tax year. If you give away products as promotions, be sure to keep track of those separately. They can be advertising or promotions. Items under $4 are not limited.
  • 16. Recordkeeping You may choose any recordkeeping system suited to your business that clearly shows your income and expenses. Except in a few cases, the law does not require any special kind of records. Your recordkeeping system should also include a summary of your business transactions. Your books must show your gross income, as well as your deductions and credits. For most small businesses, the business checkbook is the main source for entries in the business books.
  • 17. How long should I keep records? The length of time you should keep a document depends on the action, expense, or event the document records. Call your tax professional for details, but the general rule of thumb is 4 years. There are many exceptions to this rule!
  • 18. Family Employees Hire your responsible teenage son to keep inventory for your business or answer the phone. This results in an additional business expense deduction for you, as well as income for your child. Be sure to document all the hours worked by family members (or any employee you hire) in case you are ever audited.
  • 19. In conclusion: By having a home-based business you can enjoy substantial tax deductions. Keep excellent records. I find those that wait until the end of the year miss many expenses. A home-based business also is more productive as you do not have commute times etc. It is much easier to attract business builders due to the low overhead and startup costs.