The Internal Revenue Service determines whether your claimed home based business tax deductions are legal using various criteria. Is your home based business really a business or a hobby? Are the deductions claimed really for business use or personal? Is your business a scheme masquerading as a business? These are some of the questions that must be answered to ensure your home business tax deductions are legal in the sight of the IRS. The IRS has surmised that home businesses are fertile ground for tax fraud and look closely at returns to weed out any abusers of home business tax deductions.
Some but not all home based business tax deductions you may qualify for are: home office space and a portion of utilities, telephone, maintenance costs, office Furniture, cleaning expenses, licenses and regulatory fees, air fares, auto expenses ,books and magazines, educational expenses, meals with business clients, laundry expenses (When Traveling), and advertising.
Business or Hobby?
Your home based business could be classified as a hobby rather than a business by the IRS. The is a critical distinction. Why? Many businesses will have an operating loss during a tax year. This loss is used to offset any income from other sources. In contrast, a loss from a hobby is not deductible and cannot offset other sources of income. To put this simply, in a business you have income from sales and losses from expenses. The two offset or counter each other. In a hobby it is usually one way to the IRS. Everything you make is taxable and everything you spend is your contribution to the hobby, and not eligible for a home based business tax deduction.
Really, is it a business?
Here’s how the IRS distinguishes between a home based business and a hobby:
The manner in which you conduct business. Do you maintain accurate books and records? The amount of time you devote to operating the business. Do you have expectations that your assets used in the business will appreciate in value? Whether you have a history of success in other activities. Your history of income and losses. Do elements of personal pleasure or recreation exist? Do you have a DBA, business checking account, or a business phone? Is this your sole source of income? If so, the IRS is more inclined to consider the activity a business.
Home Office Let’s say a taxpayer’s activity is classified as a business and that there is a office in the taxpayer’s home, additional criteria must be met before any home based business tax deductions are allowed for the office.
A home office must be used exclusively and on a regular basis as the principal place of business by the taxpayer and at no time used for personal or family use. Two exceptions to this exclusive use test are: (1)A area of the home that is used to store inventory, it must be a specific and identifiable. (2)The home is used regularly to provide day-care services to children, handicapped persons, or the elderly.
A home business tax deduction can also be taken if the home office is used to conduct administrative or management activities, and the taxpayer has no other fixed location in which to do so. Additionally, a home business tax deduction is allowed for business expenses associated with the regular use of a separate structure that is not attached to your home.
Personal Vs. Business Expenses IRS section 162 at http://www.irs.gov/pub/irs-drop/rr2000-4.pdf allows for:
A home based business tax deduction for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. It continues by giving these examples:
A reasonable allowance for salaries or other compensation for personal services actually rendered.
Traveling expenses (including amounts expended for meals and lodging that are not lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business. This does not include lunch during the average day.
There are many tax benefits and deductions available to the home based business owner. You should determine that you are a business, the correct amount of your taxable income and know exactly what home business tax deductions to include and exclude from your home business tax return. Consulting a tax professional and some tax software can best help you determine which home based business tax deductions your business qualifies for legally.
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