Home-based businesses are the fastest growing form of business start-ups because of their flexibility. What benefits do you enjoy from working at home opposed to going into the office?
1. Less Commute Time…people on average have an hour commute to and from their offices. Working from a home office leaves more time for income-producing activities.
2. When you lease or own office space, the size of your business if fixed to the size of the space. Being tied to a long-term lease may prevent you from downsizing when it makes sense to do so. You can hire however many people you need working from a home office. You can work longer or shorter hours to right-size your business.
3. Flexibility of working hours…this is huge for those who are juggling children or other obligations. You can accommodate clients/customers in different time zones and your family’s schedules.
4. Low Overhead costs…you are not renting office space or paying office utilities. You save money on gas and wear and tear on your car by not having a commute. You can be more flexible in your pricing decisions than competitors who must adhere to those fixed costs.
5. You can determine the viability of a business idea before investing a lot of money. Forbes says 50% of new businesses fail. If you were paying for office space right off the bat, a start-up failure could be costly.
6. Income Tax Deductions…tax benefits of operating a home office can be lucrative. If your situation qualifies, you can deduct a portion of your home’s expenses, such as mortgage interest, property taxes, utilities, repairs, and maintenance, against your business income. To qualify, your home office must be your principal place of business and you can only deduct the proportionate amounts of the total expense which are directly related to your business. For example, you live in a 1300 square foot home and you home office is 300 square feet. That is 23% of your total square footage. So, 23% of the expense is related to your business. Now, you cannot create a loss with your home office expenses, however, you can carry the loss forward to future years if you do not have enough business income to use them up in the current year.
Let us talk about the most common self-employment deductions.
1. The self-employment tax refers to Medicare and Social Security taxes that self-employed people must pay. This includes freelancers, independent contractors, and small-business owners. The Self-employment tax rate is 15.3%, which consists of 12.4% for Social Security and 2.9% for Medicare. W2 employees share this expense with their employer, both pay 7.65%. An additional .9% Medicare tax rate applies if your total income is above a certain threshold for your filing status. The Married Filing Jointly threshold is $250,000. You have $100,000 in Self-employment income and your spouse has $160,000 in employee wages. Your total income is $260,000, so you will pay the additional .9% Medicare tax on the $10,000 by which your total income exceeds the $250,000 threshold. You are probably wondering how paying extra taxes to be your own boss is a benefit. Well the IRS treats the “employer” portion of the Self-employment tax as a business expense and you get to deduct it accordingly.
2. The home office deduction is one of the more complex deductions. Just remember, the cost of any workspace that you use regularly and exclusively for your business, regardless of whether you rent or own it, can be deducted as a home office expense. You have two choices for calculating your home office deduction: the standard method or the simplified method. You do not have to use the same method every year. The standard method requires you to calculate your actual home office expenses and keep detailed records, in the event of an audit. The simplified method lets you multiply the IRS-determined rate by your home office square footage. The simplified method is calculated at $5 per square foot, with a maximum of 300 square feet, the most you can deduct is $1,500. To use the simplified method, your home office must not be larger than 300 square feet and you cannot deduct depreciation or home related itemized deductions. The simplified method might be a clear choice if you are in a rush or cannot pull together good records of your deductible home office expenses. If you want to make sure you are claiming the largest home office deduction you are entitled to, you will want to calculate the deduction using both methods.
3. Internet and Phone Bills…Regardless of whether you claim the home office deduction, you can deduct the business portion of your phone, fax, and internet expenses. Only deduct the expenses directly related to your business. For example, you can deduct the internet-related costs of running a website for your business. If you just have one phone line, you shouldn’t deduct the entire monthly bill because it includes both business and personal use. The IRS says you can deduct the cost of basic local service plus taxes. You can deduct 100% of the additional cost of long-distance business calls or the cost of a second line dedicated solely to your business.
4. If you are self-employed, pay for your own health insurance premiums, and are not eligible to participate in a plan through your spouse’s employer, you can deduct all of your health, dental, and qualified long-term care insurance premiums. You can also deduct premiums you paid to provide coverage for your spouse, dependents, and children under age 27, even if they aren’t dependents on your taxes.
5. Meals are tax deductible when you are traveling for business, at a business conference, or entertaining a client. The meal cannot be lavish or extravagant under the circumstances, and you can only deduct 50% of the meal’s actual cost if you keep your receipts, or 50% of the standard meal allowance if you keep records of time, place, and business purpose of your travel but not your actual receipts. The standard meal allowance can be found on the U.S. General Services Administration (GSA) website for each tax year. The lunch you eat alone at your desk is not tax deductible. Prior to tax year 2018, meal and entertainment expenses were in unison. The TCJA eliminated entertainment expenses. So, if you are entertaining a client the meal must be identified as a separately stated item on the receipt or invoice or billed separately period for it to be tax deductible.
6. Travel…Business travel must last longer than an ordinary workday, require you to sleep or rest, and take place away from the general area of your tax home (outside the city where your business is located). You should have a specific business purpose planned before you leave home and you must actually engage in business activity—finding new clients, meeting with clients, learning new skills directly related to your business—while you are on the road. Handing out business cards in the casino will not make your Vegas trip tax deductible. Deductible travel expenses include the cost of transportation to and from your destination (plane fare), the cost of transportation at your destination (car rental, Uber, etc.), lodging and meals. You cannot deduct lavish or extravagant expenses. You do not have to go for the cheapest options either, but you do want them to be reasonable. Your travel expenses for business are 100% deductible, except meals are limited to 50%. If your trip combines business and personal things get a little complicated; however, you only deduct the expenses related to the business portion of your trip. If your non-employee spouse joins you on a business trip, you can only deduct the portion of lodging and transportation that would have been incurred if only you had traveled.
7. Vehicle Use…When you use your car for business, your expenses for those drivers are tax deductible. Make sure to keep excellent records of the date, mileage, and purpose for each trip, and do not claim personal car trips as business trips. You can calculate your deduction using either the standard mileage rate determined by the IRS (57.5 center per mile in 2020) or your actual expenses. The standard mileage rate is the easiest because it requires minimal record-keeping and calculation. You just write down the business miles you drove and the dates you drove them, then multiply your total business miles by the standard mileage rate. This is your deductible expense. To use the actual expense method, you must calculate the percentage of driving you did for business all year as well ass the total cost of operating your car, including depreciation, gas, oil changes, registration fees, repairs, and car insurance. If you spent $5,000 on car expenses and used your car for business 20% of the time, your deduction would be $1,000.
8. Interest…Interest on a business loan from a bank is a tax-deductible business expense. If a loan is used for both business and personal purposes, the business portion of the loan’s interest expense is allocated based on the allocation of the loan proceeds. Credit card interest is tax deductible only on business purchases. It is always cheaper to spend only the money you already have and not incur interest expenses at all. A tax deduction only gives you some of your money back, not all of it.
9. Publications and Subscriptions…The cost of specialized magazines, journals, and books related to your business is tax deductible.
10. Any education expenses you want to deduct must be related to maintaining or improving skills for your existing business; the cost of classes to prepare for a new line of work is not deductible.
11. Business Insurance…If you pay premiums for any type of insurance to protect your business you can deduct the premiums. Examples, fire insurance, car insurance, credit insurance, business liability insurance.
12. If you rent out an office space, you can deduct the amount you pay for rent. You can also deduct amounts paid for the equipment you rent. If you must pay a fee to cancel a business lease, that expense is deductible also. You cannot deduct rent expenses on property you own. Rent must be reasonable in amount. Rent that you would pay to a stranger is considered reasonable.
13. Startup Costs…IRS requires you to deduct major expenses over time as capital expenses rather than all at once. However, you can deduct up to $5,000 in startup costs in the first year of active trade or business. Examples of tax-deductible startup costs include market research, travel related costs to starting your business, scoping out potential business locations, advertising, attorney fees, and accountant fees. Professional fees to consultants, attorneys, accountants, etc. are deductible at any time. Equipment and vehicle purchases are not considered startup costs but can be depreciated or amortized as capital expenses.
14. Advertising…Do you pay for FB ads, Google Ads, website, billboard, TV commercial, or mailed flyers? These advertising expenses are all tax-deductible.
15. Retirement Plan Contributions…you can deduct self-employed retirement plan contributions. Contributions to SEP-IRAs, Simple IRAs, and solo 401 (k)s reduce your tax bill and help rack up tax-deferred investment gains for later. Contribution limits vary by plan type and the IRS adjusts the maximums annually. You cannot contribute more than you earn, and this benefit will only help if you have enough profits to take advantage of it.
There are more deductions available than those listed here, but these are some of the biggest ones. Office supplies, credit card processing fees, tax preparation fees, and repairs and maintenance for business property and equipment are also deductible. Still, other business expenses can be depreciated or amortized, meaning you can deduct a small amount of the cost each year over several years.
Remember, any time you are not sure whether a cost is a legitimate business expense, ask yourself, "Is this an ordinary and necessary expense in my line of work?" This is the same question the IRS will ask when examining your deductions if you are audited. If the answer is no, do not take the deduction. And if you are not sure, seek professional help with your business tax return.