Tax Deductions for Homebased Entrepreneurs
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Q: My business is homebased-operating out of my home. Am I entitled to any business tax deductions as a result of that?
A: Yes. You are entitled to the normal business tax deductions wherever you operate your business. In fact, because your business is homebased, you may be entitled to take a special home-office deduction, but even if you don't qualify to take this deduction, you may still deduct the "ordinary and necessary" expenses that apply to the operation of your business.
How the owner takes a home-office deduction is to some degree a function of the business's legal form of business organization. There are three ways a small-business owner can consider qualifying for a home-office deduction: (1) If the business is operating as a either a sole proprietorship or a one-member Limited Liability Company (LLC); (2) if the business is operating either as a partnership or a multimember LLC, electing to be taxed as a partnership; or (3) when the owner of the business is also considered an employee of the business-as in the case of C and S corporations or an LLC, electing to be taxed as a corporation.
The next consideration in qualifying to take a home-office deduction is that you must be using a portion of your home for your business, and be doing so on both a regular and exclusive basis. "Regular" means that you use a specific area continuously, as opposed to occasionally or incidentally. "Exclusive" means that either you do not use this specific space for personal use, or if you do, that you pro-rate between personal and business use.
The third element in qualifying is that this home office is your principal place of business-used regularly and exclusively for business, and that you have no other fixed location where you conduct substantial administrative and management activities of your business.
If you qualify to take a home-office deduction, you will be entitled to the following deductions, pro-rated between personal and business use: depreciation on the house, home mortgage interest and real estate taxes (or rent), home insurance, utilities, wages for domestic help and local phone service (excluding your basic service).
Whether or not you qualify to take a home-office deduction, you are entitled to take the following "ordinary and necessary" business tax deductions: professional services (such as accounting, attorney and consulting services), logistical support (alarm systems, cleaning, long-distance phone service, office supplies, postage, shipping, printing, repairs and maintenance), the cost of financial services (such as bank service charges), your car, your office equipment, furniture and fixtures, travel, entertainment, retirement, hiring your family, tax-free owner benefits (such as health insurance coverage), wages and salaries, marketing, insurance, payroll taxes and other non-income taxes.
You cannot, however, take home-office deductions that create a loss during a current tax year. After the business's taxable income has been reduced to zero (by taking all allowable business tax deductions), any remaining unused business tax deductions (referred to as a net operating loss, or NOL) can be carried back, to reduce the previous year's business income, and forward, to reduce the future year's taxable business income. This process can continue until the entire NOL has been used up. Note: This limitation does not apply to the "ordinary and necessary" business tax deductions, meaning that after these deductions reduce your taxable business income to zero, they can be applied as reductions of your other (personal) taxable income.
Note: The information in this column is provided by the author, not Entrepreneur.com. All answers are general in nature, not legal advice and not warranted or guaranteed. Readers are cautioned not to rely on this information. Because laws change over time and in different jurisdictions, it is imperative that you consult an attorney in your area regarding legal matters and an accountant regarding tax matters.
David Meier is the founder and COO of Business Development Coaching, a company that provides small-business owners with ongoing business coaching.