Owners of home-based businesses can take advantage of a slew of tax deductions that will help them reduce their taxable income and save on income taxes. The home office deduction is a tax break, especially for home-based businesses. Other deductions are similar to those that other small businesses get to take. Making full use of tax deductions can help improve the after-tax profitability of home-based businesses and solidify your financial position. To get help with your home-based business taxes and other financial matters, consider talking to a financial advisor.
Deduction for Using Your Home as an Office
Deductions help reduce the taxable income reported by individuals and businesses and can reduce the taxes they owe as well. The home office deduction is unique to home-based businesses. Employees who use part of their home to work remotely for an employer can’t claim it. Businesses that aren’t home-based also don’t qualify. Not all home-based businesses have deductible home offices either. However, those that do can look forward to a potentially significant break at tax time.
The first requirement for a home office deduction is that the space for the office is set aside for exclusive use for the business. A room used part of the time as an office and part of the time as a spare bedroom doesn’t qualify.
The second requirement is that the office is the principal place of business. This excludes small business owners who have another office or other place of business outside the home where they do most of the work of running the business. If you frequently work outside the home visiting clients, however, you could still qualify for this deduction as long as you don’t have another office.
Home Office Expense Deductions
If you have expenses used only for your home office space, you can deduct those. For instance, if you pay an electrician to rewire a broken light fixture, you can subtract the bill from taxable business income for that year. If you do a major renovation or improvement, however, you will likely have to depreciate it and claim the deduction in small amounts over a number of years rather than all at once.
You can also deduct a portion of the repairs and ongoing operating expenses incurred by the entire house. The IRS permits two ways to figure the amount you can deduct. Both techniques are based on the size of the home office, so you’ll need to measure its dimensions and calculate square footage.
To use the direct method, you multiply the size of the office in square feet by $5. If you have a 250 s.f. office, your deduction would be $1,250.
The indirect method allocations a portion of the actual expenses incurred by the whole house to the home office. These expenses may include repairs, depreciation, homeowner’s insurance, utilities, telephone and Internet service, cleaning and the like
To use the indirect method, add up all your household expenses and multiply by the percentage of the house taken up by the office. If your office is 250 s.f. and the house is 2,000 s.f., the office takes up 12.5% of the house. If household expenses come to $8,000, multiply that by 12.5% to get $1,000. That, plus any expenses incurred solely for the office, is your home office deduction.
Other Business Tax Deductions
In addition to the special home office tax break, home-based business owners may be able to take many of the usual small business tax deductions. These include:
- Wages paid to any employees: Owners of home-based businesses owners can’t deduct their own wages or salaries, however.
- Employee benefits: If you have employees then you can deduct employee-related expenses like healthcare benefits just like any other business.
- Operating expenses: Interest, insurance and depreciation may all be deductible to the extent the vehicle is used for business.
- Equipment: Rentals of equipment, exhibit space or other tools or costs used in the business.
- State and local taxes may be deductible from your business income.
- Costs of business loans: Mortgage interest can’t be deducted from home-based business income if it’s already deducted elsewhere on the owner’s personal return.
- Insurance premiums: Premiums for any coverage necessary for the business, such as liability, can be deducted. Home hazard coverage can’t be deducted here but a portion may be deductible as a home office expense.
- Advertising and marketing: Business cards, flyers, display ads and other marketing costs are deductible.
- Professional fees: Such as legal and accounting help.
- Bank charges: Only charges for business bank accounts are deductible. Personal checking and savings fees are not.
- Office supplies: Anything needed to run your office, no matter where it is located, could be a tax deduction.
- Bad debts: Any business with bad debts can use those debts as a deduction in their tax liability if their situation qualifies.
The Bottom Line
Home-based businesses can use deductions to reduce taxable income and ultimately what they may owe in taxes. Home-based businesses can take many of the same deductions that other small businesses have, including those for employee wages and benefits, advertising, utilities and interest. Home-based businesses also can often get one special deduction, for having a home office, especially if it’s a significant portion of their home or they use that office to meet with clients.
Tips for Tax Planning
- A financial advisor can give you insight into how to take the best advantage of your potential home-based business tax deductions. If you don’t have a financial advisor, finding one doesn’t need to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Owners of home-based businesses may be eligible to set up retirement plans for self-employed people. SEP IRA and solo 401(k) plans can provide current-year tax deductions while also allowing investment gains to multiply without incurring additional tax until withdrawals begin.
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