Your home-based business is in a unique tax situation. It’s important to realize that if you conduct your business from home, you can deduct all the same expenses other businesses can. Moreover, you can access further deductions that will mean lower taxes you pay on your business income. Add to that the deductions of a home office and you’re really looking to lower taxes. However, be aware that calculating these deductions can be slightly different.
Direct Business Expenses
Any expenses that are directly related to the running of your business are deductible regardless of where your business is located. This includes home-based businesses. This means office supplies, raw materials, product samples, entertainment, and meals can all be included in your deductions. Be sure to keep your receipts for business related expenses so you can back up your deduction claims. Your expenses should be reported on Schedule C of the 1040 return form.
If you find that you have more expenses than revenue, you are able to claim the net loss against other sources of income or carry it forward for future years.
Home Office Deductions
If your business is located in your home, you will be able to claim some expenses of your home operations as a business expense. The IRS allows a home office deduction if you meet one of the following two criteria:
- The home office is your main place of business, or
- You regularly and consistently receive clients there.
This means that if you do not rent or own office space somewhere else, your home office is your main place of business. To meet the second criterion, you can have an office outside your home, but you see clients often in your home office. An example would be a lawyer who regularly meets clients in his home office in the evenings.
Calculating a Home Office Deduction
To figure your home office deduction, calculate the percentage of your home devoted to your office. This can be done in two ways. In the first manner, divide the square footage of the home office by the total livable square footage of the house. The second manner is to divide the number of rooms taken up exclusively by the home office by the number of rooms in the house. Be sure to calculate both ways and then choose the one that gives you the biggest percentage. Then, apply this percentage to home expenses, such as mortgage interest, utilities, property taxes, repairs, and maintenance. Apply the percentage to home expenses on the Schedule C form and this becomes your deduction. If your home office expenses create a net business loss, there are rules about which ones can be deducted and which must be carried forward in the future.
If you drive your personal car for business, you are allowed to deduct a portion of vehicle expenses against your business income. This is similar to businesses which deduct vehicle expenses. However, having a home office means the calculations are different. With a home office, you can include driving to and from your home for business purposes in your mileage calculation. You can also include driving between your home and another office. To calculate the appropriate deductible vehicle expenses, you can choose one of two methods. You may either multiply the IRS mileage rate ($0.55 at the time of writing) by the total miles you drove throughout the year for business or accumulate all your actual car expenses and apply the percentage of business miles versus total miles driven during the year.