One of the best things about having a home-based business is that it offers you opportunities for tax deductions. However, with so many people working from home in the pandemic, it can be difficult to tell if you own a home-based business or just work from home. Figuring out if you own a home-based business and how to make the most of your available tax advantages can make a huge difference in your actual income.
Is my home the principal place of business?
To claim a percentage of your home as a business deduction, it must be your principal place of business. That does not mean that you only do business at your home. It simply means that you use part of your home exclusively and regularly for business.
Remember that the IRS also allows you to have an expensive idea of “home.” If you work in your garage, a shed, or other separate building on your property, and you use it as your principal place of business, it qualifies for the deduction. Just keep in mind that, like a room in your home, you have to regularly and exclusively use it for that business.
What makes a home a principal place of business? It does not mean that you must do most of your work from your home. Many salespeople and contractors do most of their work at outside locations. A better way to think about it is if you use your home more than any other single place for business. If that is the case, it is probably safe to consider your home your principal place of business.
Do I regularly and exclusively use part of my home for business?
That is the requirement that prevents many people, even those with home offices, from claiming the home-based business deduction. To qualify for the deduction, you have to regularly and exclusively use part of your home for business. That means that the space should not be pulling double-duty in your home.
For example, do you work from the kitchen table, which you clear off every night for family dinners? That is not the regular and exclusive use. Do you use a spare bedroom as an office but let guests stay in it? Once again, that is not the regular and exclusive use.
Unless you live in a substantial home with many rooms, it can be difficult to regularly and exclusively use any part of it for business. However, you can regularly and exclusively use parts of rooms for business. If you have a guest room with your desk, computer, printer, filing cabinets, etc., and a guest bed, you can claim part of the room. You need to look at what percentage you dedicate exclusively to business.
You may also want to look at rearranging your home. How can you maximize the space you use exclusively and regularly for business without infringing on your actual living space? Get creative. Some people have converted closets to business spaces. One client who owned her own business used her dining room exclusively to show products and conduct sales. She moved the family’s dining table into a living room corner to keep that use exclusive.
Do I own my business?
That is a very important question, which many taxpayers overlook. If you work for an employer, even if you work primarily or even only from home, you cannot take the home-based business deduction.
That was not always the case. The law changed in 2018, and the current law expires in 2025. However, if you are an employee, you cannot qualify for the home-based business deduction under current law. Even if everything else about your home office would be eligible, that is true. It is even true if your employer, like so many, did during the pandemic, closed the physical office and required employees to work from home.
However, this is very important however, if you use your home to run a side-gig or other business, you may be able to take a deduction for that portion of your home. Even if you work from home as an employee during your main gig, that is true. How do you know if this applies to you? Are you required to file a Schedule C to report self-employment income? If so, and you meet the other requirements for a home office, you can probably take the deduction.
What about MLMs?
Are you part of a multi-level marketing (MLMs) business? Mary Kay, Avon, Herbalife, and Amway are just a few MLMs popular in our area. If you participate in one of these MLSs, you qualify as self-employed. You could take advantage of the home-based business deduction. You just need to make sure you dedicate part of your home exclusively to the business. That can be as simple as saving an area for storage and display of your products. Remember, you do not have to use a whole room. Still, you have to use whatever percentage of the space you are claiming for business exclusively for that business.
Do I have to own my home to take advantage of tax tips for home-based businesses?
No. Whether you are a homeowner or a renter, you can take advantage of home-business tax deductions. You can also use deductions regardless of the type of home you have.
Do I have to keep detailed records to claim my home business deduction?
Not necessarily. Almost a decade ago, the IRS simplified its home office computing deductions. The simplified option lets you determine your deduction based on the square footage of the office (or other dedicated business space) you have for your work in your home. You can also use the regular method, which allows you to track actual expenses. You can then select which one gives you a significant tax benefit.
If you use the regular method to determine your actual home office expenses, you can consider things like:
- Mortgage interest
Generally, deductions for a home office depending on the percentage of your home devoted to business use. So, suppose you use a whole room or part of a room for conducting your business. In that case, you need to figure out the percentage of your home devoted to your business activities.
Beyond the Home Business Deduction
While it is great to take advantage of tax breaks, the home business deduction is only a small part of running a home business. We have some other valuable tips that can help you maximize your profits.
Can You Work from Home?
In other words, are you allowed to run your type of business from your home? State, county, city, and even neighborhood/HOA rules can influence whether you can run certain enterprises from your home.
If your work involves remote computer work and no clients on your premises, you are probably in the clear. However, suppose you will have clients in your home or store certain types of materials. In that case, you may need permits, licenses, or to register your business. You can check with your local government to find out the requirements.
Keep Good Books
Many small business owners dread keeping the books. They find it tedious, so they let it slide. The problem is that it keeps you from understanding profitable and unprofitable parts of your business. You need to keep those records up-to-date. You can simplify the process by setting up bookkeeping software or outsourcing your bookkeeping. However you choose to tackle the problem, you should always have a thorough understanding of your business’s financial health by glancing at your books.
Do Not Forget About Billing
So many self-employed people work for free. They do not do it on purpose, but they finish work and fail to get paid. Before you do any work for any client, including friends and family, outline payment terms in your contract. If those terms require payment during the project, get the money before continuing with the rest of your work. Invoice clients as soon as projects are complete. Set up a system to send follow-up invoices. Have a plan for handling no-pay clients because they happen to even the best business owners. If you are not prepared to handle accounts receivable, you will end up working for free.
You may think that your homeowner’s or renter’s insurance will cover any losses you take as a home-based business. On the contrary, those policies may expressly exclude losses or liabilities resulting from a home-based business. Talk to an insurance agent about business-specific coverage. It is surprisingly affordable and can cover you when your business insurance does not.
Keep Your Technology Up-to-Date
Technology is constantly advancing. If you cannot keep up, you will not seem professional to potential clients, customers, and suppliers. That does not mean you have to replace your hardware constantly. It does mean using upgraded software. It also means ensuring you have access to enough bandwidth to meet your needs. You also need a backup. What happens if you lose power or internet at your home? The solution may be as simple as a wifi hotspot on your phone and keeping a laptop charging so that it is available if you lose power or internet. You just want to make sure you have a backup plan.
Pay Your Taxes
One of the biggest mistakes newly self-employed people make is failing to save for taxes. If your business is a success, you will owe taxes at the end of the year. You may even make enough to qualify for quarterly tax payments. Are you prepared to pay those taxes? You should figure out your projected income and save a portion of it each month so that you can meet your tax obligation. You can tackle this in several ways. One of our clients is self-employed, but her husband is not. They file jointly, so they maximize his work deductions to cover income from her home business. Other clients set up dedicated tax savings accounts.
Talk to a Professional
The best advice we can give home business owners is to have a conversation with a business professional. You may not need an ongoing professional tax or business services if you run a simple side-gig. However, setting your business up correctly from the beginning can help you avoid pitfalls that frequently snare small business owners.