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 is 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.
- Keep detailed receipts for all expenses you deduct.
- Deductions will be different if you are self-employed vs. an employee.
- Some deductions, like the home office deduction, are easy to misunderstand or misrepresent. Be honest with your assessments.
- Despite the common myths, there is no one specific deduction that may trigger an IRS audit.
- The best way to ensure proper tax compliance is to file your taxes with a tax professional.
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 expenses like the installation of a bird fountain in the backyard—those types of stretches make IRS auditors less agreeable.
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.
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.
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 a 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 proof justifying the deduction, then perhaps it isn't a deduction you should be taking.
How Much Can You Write Off for a Home Office?
The IRS states that you can "choose one of two methods to calculate...home office expense deductions." You can either claim a rate of $5 per square foot for business use of the home with a maximum of 300 square feet and therefore a maximum deduction of $1,500, or you can use what the IRS calls the "regular method." This method involves claiming deductions based on the percentage of the home devoted to business use.
What Expenses Can I Write Off for a Home Office?
When taking the home office deduction, the IRS allows you to write off mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent. However, you must meet specific requirements to claim home expenses as a deduction. The two basic requirements are that there must be the exclusive use of a portion of the home for conducting business on a regular basis, and that the home must be the taxpayer's principal place of business.
Can I Deduct Home Office Expense if I Work Remotely?
Yes, you can, as long as you meet the basic requirements the IRS sets out for those wishing to claim the expenses as a deduction. If you work remotely and often change locations, this can become more complicated, as your workspace will change in size and possibly alternative use. Those working remotely should seriously consider hiring a tax preparer to handle these intricacies.
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. Reading 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.