It is said so often that it has become a bit of a cliché, but one of the great virtues of starting a home business are the tax breaks you can claim. Another popular belief surrounding home businesses, however, is that claiming aggressive—and maybe slightly exaggerated—write-offs is a sure-fire way to attract IRS auditors. In this article, we'll look at some of the more popular home business write-offs as well as some tips on how you can legitimately claim them.
(Homebodies can save big on their tax bill. Learn how to get in on the action. Check out How To Qualify For The Home-Office Tax Deduction.)
1. Keep a Business Journal
Being audited is not the end of the world. However, being audited and not having the records to back up your deductions can be a nightmare. The simplest way to avoid this unpleasant situation is to keep a daily log of your home business activities. Did you buy paper for the printer in your office? Write it down and either attach the receipt to the page in the case of a hardcopy or scan the receipt in if you are keeping a digital log. The same goes for mileage, phone calls and other costs, as well as payments received by your business.
The more detailed your accounts are, the easier it will be to face an audit. Compiling your daily reports into a monthly tracking sheet will drastically shorten the time it takes you to get your taxes together, and it will have the added benefit of providing a snapshot of your business month-to-month.
2. Write-Off Your Workspace
Writing off a home office can be particularly attractive if you have a line of work that can be neatly confined to a dedicated room. You can still write off part of a shared room, but in either case, space is calculated as a percentage of the total house or apartment area. That percentage is applied to all the related costs, including utilities, insurance, rent or mortgage payments and so on. Do not claim unrelated expense like the installation of a bird fountain in the backyard—those types of stretches make IRS auditors a little testy.
3. Update Your Equipment
Office furniture, software, computers, and other equipment are all 100% deductible within the year that the cost is incurred—you don't need to depreciate. There is an upper limit and the purchases must be majority-usage (primarily used) and necessary or helpful for business. Within those generous guidelines, however, you should have no problem keeping current. However, a widescreen TV and La-Z-Boy for the office is going to be a hard sell.
4. Save for Retirement
If you are working solely for your home business, you will have to pay the employer's share of Social Security and insurance, but you can deduct half the amount of Social Security and the total premiums for you and any employees (more on that later).
5. Talk Up a Storm
If chatting with clients is a necessary (or helpful) part of your business, it may be worth getting a second phone line or a dedicated business cell phone, as both of these are 100% deductible. If you only converse with clients occasionally, you can still write off the costs by noting the dates, times and reasons for the calls and then circling the items on your regular phone bill to deduct at tax time.
6. Get Connected
Similar to the phone bill, you can deduct part of the cost of your internet if you use it for business. There is no absolute percentage to use, but it will be difficult to write off more than 50% if other members of your family are using it for non-business purposes. Be reasonable and pick a defensible percentage that you won't regret in the case of an audit.
7. Entertain Us
You can wine and dine clients—emphasis on clients (preferably paying or likely to pay clients)—and get a tax break. The tendency for business owners at all levels to abuse this write-off has scared many home business owners away from claiming it. However, it is acceptable for you to take out a client for a meal and some entertainment. It will be easier to defend a $200 deduction for a client who has brought you a lot of business than the same meal for a buddy who paid you $20 for an hour's work over the entire fiscal year.
8. Take a Trip, Not a Vacation
Have to hit the road to expand your market? Save your receipts. On business trips, your travel expenses are 100% deductible. Although food expenses were deductible at only 50%, Congress made temporary provisions in the Consolidated Appropriations Act, which was signed into law by President Donald Trump in December 2020. The bill allows business meals to be fully deducted as long as they are paid for or are incurred before Dec. 31, 2022.
Keep all of your receipts because even things like dry cleaning and tips are considered a necessary expense when you're out pounding the pavement in new markets.
Your local day-to-day mileage incurred for business purposes can be written off as well, so give the same attention to tracking your mileage on smaller trips that you would to the expenses of an overnight trip. For many people, the mileage deduction is the more realistic deduction than first-class tickets to New York. Remember, you have to be able to justify any trip and preferably show the payoff to your business resulting from it.
9. Employ (Not Just Pay) Your Family
You can use family members as employees and deduct their salaries as long as you can account for their work and pay the going rate. If you have a business that lends itself to having a spouse and kids help out, then use that labor pool. You'll likely pay less than market rates for the help, and you can deduct insurance premiums for them as well.
As an added bonus, children under the age of 17 don't incur the Social Security tax, but they can still make contributions to a Roth IRA—so you can teach them a work ethic and saving habits in one go.
10. Make Justifiable Deductions
The most important tip has been a theme throughout, but it is worth repeating: just because you have a home business doesn't mean you can go crazy with deductions. If you don't think you can face down an auditor with detailed proofs justifying the deduction, then perhaps it isn't a deduction you should be taking.
The Bottom Line
A home business can be a rewarding experience, both for the extra income, it can bring in and the tax breaks it yields. A complete read through the IRS small business publications is well worth your time. You will learn more about the deductions mentioned here and what conditions need to be met to claim them.
Although it is important to keep accurate records and stick to deductions you can justify, it is also in your interest to maximize your deductions as much as you can while staying within the rules. The IRS guides are not nearly as difficult as they are made out to be, but if you still feel adrift after reading them, then finding a good business accountant will save you time and hopefully a lot of money.