Taxes and Running a Business Out of Your Home
If you’re considering the tax implications of running your business from home, then this post offers simple tips and insights to give you a strong overview and what to do to be safe if you decide to go ahead. Let’s get started with a bit of background, then answer some of the questions people ask.
Tax Code Knowledge:
This article is focused on tax deductions for a home business. It’s a good idea to become familiar with the tax laws and understand how the system works. It’s my strong recommendation when it comes to taxes that you consult with a professional for two reasons:
Reason One:
Tax laws for each country and state or province will differ, and that’s why it’s important to seek the help of a professional in your area.
Reason Two:
I know many people who want to file their taxes to save money or feel confident they can do it themselves. Maybe you know your tax laws and enjoy the processor you want to save money, but here’s my take on business taxes.
Unless you are an accountant or bookkeeper, you should seek professional advice. An accountant lives by the tax laws. They know the laws, they keep up with the changes to the tax code, and they can answer your questions without putting a lot of effort into it.
You should be focused on your business and let the pros handle your taxes.
With that said, let’s take a look at home business taxes, and when you consult with your accountant, they will be able to confirm your information or let you know the best route to take for your situation.
The Core Principal of a Tax Deduction
It may be a bit confusing when it comes to tax deductions. Once you have a core understanding, the confusion will disappear.
A tax deduction reduces the amount of money you are taxed on.
Here’s a simple example. You have a total revenue of $100,000 for the year. It cost you a total of $60,000 to generate that revenue.
Your expenses are referred to as a tax deduction. In the above example, you are taxed on $40,000, not the $100,000 of revenue, because it costs you $60,000 to make the $100,000.
When taking deductions, it gets tricky in some situations, like running a business from your home. A portion of your home expense is tax-deductible, and some are not, which are some of the topics we will go over in this post.
Home Business Tax Questions and Answers
There are many tax questions regarding running a business from home and what is allowed and what is not. You’ll find insights to questions like, “Do I qualify for the home office tax deduction?” and “How To Run a Business From Home Legally” in the section below that are quick and to the point.
Let’s get started!
What Constitutes Running a Business From Home
To qualify for home office tax deductions, you must be running a legitimate business from your home. It must be the primary location of the business, and you must have the intent to make a profit.
Let’s go over each for more details.
Your Home Office Must Be the Primary Location of Your Business:
You must run your business from home to qualify for the tax deduction. If you have a business you operate during the day in another location and run it from home after hours, you are not eligible for the home office deductions. Your business must be the primary place of operation.
Let’s look at another example. Let’s say you operate a business that has operations at another location. For example, operating a self-storage business, where people have a FOB, access code, or a key to access the area and their storage unit.
The administration of the business is run from home. So, this scenario could qualify for the home office deductions. The key to remember is you only run the business from your home office, not at the location of the storage unit.
Intent To Make a Profit
Intent to make a profit means you can’t open a home business so that you can write off your home expenses. You must provide proof that you intend to make a profit.
The proof falls under a few business activities and documents as but is not limited to the following:
- Keeping records of sales, expenses
- Creating a business plan
- Using the services of a bookkeeper
- Hiring employees
- Creating a separate bank account for your business
Home Office Deductions
“Exclusive and Regular Use” is a term you will come across regarding taxes and a home-based business.
Exclusive refers to the area you are using, and that area can only be used to run your business. You can’t use your living room for home use and business purposes. You can use your living room to run your business exclusively, but your family can’t use the room to watch tv or participate in other activities.
Regular Use refers to the time you spend running your business. If you tend to your business once a month, that’s not considered, regular-use and it will disqualify you from filing for home business tax deductions.
Check with your bookkeeper/accountant or local authorities to verify the information for your area.
How To Run a Business From Home Legally
“Is it legal to run a home business in a residential area?” is one of the frequently asked questions when starting a home-based business.
The answer to that question will depend on the type of business you’re running and the zoning laws for your area.
Suppose you’re running an online business where you’re providing a service, for example, website design, editing, answering service, etc. These types of businesses do not affect the neighborhood. There is no traffic, no noise, and nothing that you’re doing would affect your neighbors. It’s most likely these types of businesses are allowed in a residential areas.
On the other hand, suppose you’re opening a body shop in a residential area. A body shop service creates noise, plus customers, tow trucks, and parts deliveries constantly entering and leaving your property affects residential traffic. This type of business may not be allowed in certain residential areas.
Check With Your Municipality:
Naturally, before you start a business in a residential area, you want to check with your municipality to understand the requirements and restrictions.
Every country, state, province, and local municipality has different rules and regulations regarding running a home business. It’s to your advantage to get advice before you start planning.
Speak With Your Landlord:
If you rent your home, you want to make sure to look over your rental agreement or speak with your landlord. Running a business out of a home that you rent or lease may void your rental agreement.
Speak With Your Home Insurance Agent:
It’s important to speak with your insurance agent about running a business from your home. Running a business from your home could void your homeowner’s insurance unless you include your business on your insurance policy.
It’s critical to speak with your agent before you get started with any type of business. Adding to your existing policy is simple to do, and it’s much better than paying for insurance that won’t cover you because you failed to let your agent know about the business activities.
How Much Does a Home Business Have To Make To File Taxes?
This question makes me think that people are worried about paying taxes.
I’d recommend focusing on running your business and succeeding.
Your taxes are a percentage of your profits. Suppose you have to pay a million dollars in taxes from your small business, you are blessed because that means you are making a lot of money, and your business is successful!
Back to answering the question, it depends on the tax code for your area, but taking a quick look, once you have revenues over $400, you will need to start filing for taxes.
What Can You Write Off if You Have a Home-Based Business
The advantages of running a home-based business include keeping expenses down, low startup costs, and you can deduct some of your home expenses. The first thing you need to do is determine how much space you are using for your business. Then you can use a formula for deductions.
Calculating The Space In Your Home For Business Use
There are a couple of ways of calculating the deduction for the space you use at home for business purposes. You can take the simple way of calculating the square footage used for business and taking a flat rate per square foot.
Or
You calculate the square footage used for business and deduct the percentage from your overall allowable expenses.
Calculating your square footage of use:
Determine the square footage of your house. Next, determine the square footage of your business space.
Your business space must be the space you use exclusively for running your business. In other words, you can’t use your kitchen as an office and write off your expenses.
For example, let’s say your house is 3,000 square feet, and the area you use for your business is 20×15 square feet. Your total use is 300 square feet.
300 square feet dived by 3,000 square feet = 10%
If your total yearly home expenses are $20,000, then your deductible expense for your home business would be $20,000 x 10%, which would equal $2,000.
Method One Flat Rate:
300 square feet x $5.00 = $1500
Method Two Percentage:
300 of 3,000 square feet equals 10% used for business, therefore 10% of $20,000 in expenses equals a $2,000 tax deduction.
The two numbers are close, and naturally, the more room you use, the more you can deduct.
There are many expenses you can write off when you have a legitimate home business.
Let’s have a look at a few of them, using our 10% example.
Mortgage:
If there is a Mortgage on your home, you deduct part of the interest as a home business deduction. Using our 10% example, you would take the total interest paid for the year and multiply that by 10%, giving the amount you can deduct.
Utilities:
The utility bills for the year, including electricity, natural gas, water, sewage, internet, etc., need to be recorded and added. You would take the total amount paid for the year and, in our example, take a 10% deduction.
For example, let’s say your total utilities cost for the year is $4,200. Using our example of 10%, you could take a tax deduction of $420 (4,200 x 10% = 420)
Home Insurance:
It’s the same formula for home insurance. Suppose your yearly insurance costs are $1,200. Using our example, $1,200 X 10% equals a $120 tax deduction.
Homeowners Association Fees:
If you live in a condo, you’ll have condo fees, and these can be used as a home business tax deduction using the same formula we have been using.
Home Maintenance Fees:
Fees associated with maintaining your home can be another area to consider. This is one of those areas you want to discuss with your accountant. For example, discuss expenses associated with landscaping, renovations, lawn care, home repairs, etc.
Other Home Business Tax Deductions:
Note the above points are the deductions from your home expenses. All other legitimate business expenses are different tax deductions you need to track and deduct as you would if you were operating your business from a commercial location.
How Do I Claim a Home-Based Business on My Taxes
When starting a business, a popular approach is to start as a sole proprietorship, meaning your income and business income are one. You file your business and personal taxes under your name.
A sole proprietorship is the easiest and cheapest type of business to establish.
One of the benefits of starting this way is you can test the water. If you’re successful and see a lot of growth, then you can change your business structure from a sole proprietorship to a corporation or limited liability company.
When you need to prove your income as a self-employed individual, you will track the payments made to you from the business, referred to as a “Draw.” You would also need to use your tax returns to provide proof of income.
Conclusion:
You now have an idea of how taxes work when running a home business, and knowledge is power. With this information, you can do some planning.
Once you have decided what you want to do, I strongly suggest you speak with your bookkeeper or accountant to develop the best approach for your circumstances.
As mentioned early in this article, tax laws change and are updated regularly. The area you do business could have different laws and regulations. It’s in your best interest to consult with a professional.