Make The Most Of Your Home-Based Income Tax
by Yank Elliott, MBA &
One benefit of having your
own business is that often regular daily expenses become business expenses
under the U.S. Internal Revenue Code and are allowable as deductions from
business income. In effect this means these expenses are paid with before-tax
dollars and buy more value than if they were paid from your regular after-tax
income. One well-known business expense (not the subject of this article) is
the home office deduction. Well discuss lesser-known expenses that can
legally reduce your Federal income tax bill.
Pay attention to the ideas
discussed here. You will save time by not having to look up so many regulations
and perhaps you will find some deductions that will save your tax dollars as
well. When reading the publications from the IRS, keep in mind they are often
written in language suggesting that no deductions related to a home-based
business are allowable at all. Then, after most people decide to avoid a
business altogetheror at least decline to use a deductionthe
regulations will proceed to tell how you can use these deductions. Sick
isnt it? What this should tell you is to drill down through the
publications and see how you can use allowable expenses. Congress wrote the
regulations so entrepreneurs can retain the rewards of their labor. Use them to
your advantage all you can.
Before talking about these
deductions, a few points are in order:
deductions is part of a strategy to legally avoid a portion of your income tax.
Tax evasion, on the other hand, is illegal and carries serious consequences
including jail time; use extreme care not to become involved in any evasion
scheme. Some home-based business opportunities are marketed on the basis they
provide ways to deduct nearly all personal living expenses. See what the IRS
Many believe having a
sideline business automatically causes your returns to be audited. I have
talked with several successful entrepreneurs who have terminated their business
after two or three audits. Just because you operate a small business will NOT
cause you to be audited. None of these people gave me any other details about
their returns. It could be they deducted too many non-deductible or
Good records are a must
for substantiating every deduction you make. No matter how good your records
may be, they will not substantiate expenses that arent ordinary and
necessary for the conduct of a real business operated with the intent of
making a profit.
Do not fear an audit. Even
if you arent self-employed, your return could receive a computer score
subjecting you to further investigation. Everyone should always use the
deductions available to pay only their just share of tax but no more. Sometimes
deduction items or income sources will raise a flag in the IRS computer
program. No need to fear anything unless you intentionally did something wrong.
With your good records and good intentions what is the worst that could happen?
You may have to pay some additional tax and possibly a penalty. If your mistake
is honest, these charges will likely amount to very little.
The investigation may also
turn up a mistake that may lower your tax (this happens seldom, but it does
happen). The point is anyone is subject to audit, and if you arent a
crook, you have nothing to fear. It is certainly no reason to avoid going into
a business of your own.
Speaking of audits, what
are your chances of being audited? There is less than a 1% audit chance for
those with incomes under $25,000; even if your income exceeds $100,000 the
chance is still less than 2%. Remember these probabilities could point to you
anyway if the computer score picks up questionable items on your return.
Unfortunately there is no way to tell what score you may have.
What kinds of people have
greater than average chances of audit? Your chances for an audit increase a
little bit if you are a doctor, lawyer, or accountant. A cash business may
increase your audit profile, as will having very large deductions or charitable
contributions. Audit risk should not discourage anyone from going into
business; every taxpayer is subject to a possible audit no matter what you do
or dont do. The computer scores every return and you may be audited even
if you work for someone else and use a standard deduction. Some misconceptions
about your audit probabilities are discussed
here. The audit chance is absolutely no reason for not
having your own business.
One other thing you should
do is be sure to conduct your business in a manner acceptable to the IRS so you
wont be considered as only engaging in a hobby where you dont
expect to make a profit. Hobby losses cant be used to offset any other
income and so the value of your deductions could be lost. If you conduct your
activities as a serious business and you make a profit in at least three of the
past five years, you will usually be considered as carrying on your activities
for profit by the IRS. You can find more information on hobby vs. business
Consider this idea about
being sure your business is profitable in three years. You can simply reduce
your deductions, even if you have them, in order to show profitability in a
year. You may have to pay Self-Employment tax, but you will protect your
business deductions and your loss offsets in unprofitable years. If you fail
the hobby test in an audit, you could lose important deductions in previous
years; we hope you are profitable without having to use this little idea, but
its available if you do.
Many home business expenses will have some
aspect of personal use and must be allocated part to business and part to
personal with the personal part
non-deductible. An example of this might be borrowing money
and using 40% of it for personal expenditures and 60% of it for business
expenditures. You may deduct 60% of the interest as a business expense. The
other 40% is a personal expense and therefore not deductible.
Here are some expenses
that are allowable deductions. These are by no means every deduction possible.
If you have questions refer
here as a starting point or ask a professional tax
- Monthly fees and business kits often
required by network marketing and MLM companies.
- Licenses and permits required by
- Subscriptions to business magazines,
newspapers, and e-zines.
- Supplies like computer paper,
business cards, pens and pencils, envelopes, other items used in your
- Advertising in newspapers,
magazines, e-zines, classified ad Websites, pay-per-click, domain names,
hosting fees, Website development, and promotion of your domain to search
- Anything you give away free as
promotions like services or product samples.
- You may not deduct the cost of one
phone line to your home even if you have your office there; you may deduct cost
of business long distance on any phone.
- Additional phones used exclusively
for business or cell phones used for business are deductible.
- Internet connections used for
business are deductible such as dial-up, DSL, satellite, or other kinds.
- Bank fees for your business account
such as monthly service charges, returned check charges, overdraft fees, and
- Business postage with receipts.
- Shipping fees you pay to ship items
- Shipping charges you pay for goods
shipped to you; if these are for assets acquired they may be part of the cost
(check with your tax advisor or IRS regulations).
- Shipping paid by your customers is
never deductible by you; you need to record these charges so they will not be
included as income to you in case of an audit.
- Cost of computers, upgrades,
external drives, scanners, printers, cameras used for business, and any other
computer-related equipment is usually deductible. See
- Software used for your business also
is usually deductible (also Section 179).
- Membership fees for organizations
devoted strictly to business are deductible. Some of these are Chambers of
Commerce, Civic or public service groups, professional organizations, trade
Please note these comments
about Section 179 mentioned above. This section allows up to $105,000 of asset
purchases to be deducted as an expense without the requirement of depreciation.
There is an income limit up to the amount of taxable income. A quick read of
this section might lead a reader to think if there is no taxable income, the
related costs cant be deducted. Closer reading allows taxable income to
be computed without using any Section 179 deduction; this enables the taxpayer
to use enough of the 179 deduction to reduce taxable income to zero but any
unused portion cannot be taken against other current income. The excess 179
amount may be carried over to another year to decrease taxable income in that
Transportation costs are an important part of every businesss
expenses, especially in these times of extreme fuel prices. Here are some (but
probably not all) of the allowable transportation and related deductions and
considerations about them:
- Round trip transportation expenses
from your legitimate home office to your clients or customers place
of business are
- Actual car expenses or mileage rate.
- Records required for vehicle mileage
expenses are discussed
- If you must travel away from
your home office for duties related to your business your reasonable and
necessary expenses are
Just because a seminar is
promoted as business-related
does not mean the entire trip cost is deductible. You must
always be able to show the business purpose of your travel activities.
Here is a complete list of forms and publications you can
download from the IRS.
When you consider whether
to take actual vehicle expenses or the mileage rate, remember actual costs
require a lot of extra records. Mileage may be easier for most situations. Even
using mileage, you should keep a notebook in the vehicle and list all mileage
use including personal for the entire year. That way you can prove exactly what
your business use was in the event of an audit.
Much is said in the IRS
literature about there being no way to convert personal expenses into business
expenses. This simply is not true. If you use the home office deduction, you
have converted a significant personal expense into an allowable deduction. The
same is true of travel expenses; your legitimate business expenses are always
deductible. If you take your spouse or companion along their expenses are not
deductible but their use of your hotel room is certainly a conversion of
personal expenses into a deduction.
When you go on a business
visit to a customer or make a trip to the supply store or the bank and on the
way drop off or pick up your child at school, you have converted a personal
expense to an allowable expense. There are many ways a legitimate business
deduction can result in a personal expense conversion. You can save tax dollars
by planning trips and other activities so you can cover personal items with
normal business expenses. There is nothing wrong with this.
Always take every
deduction you think you can lawfully use. Every taxpayer may be subject to an
audit; there is nothing you can do to reduce your chances. As we have said,
What is the worst thing that can happen? You may have to pay some
additional tax; good records will probably prevent that from happening. Just be
sure you dont fail to report income and be sure not to inflate your
deductions. If youve done none of these illegal acts, there is nothing to
By all means start your
business; risk of an audit is absolutely NOT A REASON for staying away from
becoming a successful entrepreneur.
Elliott. All rights reserved worldwide.
Yank is a home-based
entrepreneur and freelance business writer living in Hurricane Alley, North
Carolina, USA. His Website is
http://www.furriwhalesworld.com. Contact Yank at