What Home Based Business Deductions Can I Take?

There are home based business deductions that you can claim on your taxes. However, be careful. Do your research as to what you can legitimately claim.

Why?

Because you want to avoid being audited by the IRS for claims you're making. Not only can an audit be an unpleasant experience, but also taxpayers and the IRS often disagree about the proper classification of an activity. There are many court cases on this issue. If you research these cases, do not rely on just one decision. The facts of each case are distinct and usually give the reader only an indication of how the IRS might rule under very specific circumstances.

Now, it may be the case that you are simply overlooking many ideas about what home based business deductions you can claim. Perhaps a newspaper or magazine article brings to mind home based business deductions you could claim that you might not otherwise consider.

I want to encourage you to do further research before you take home based business deductions that someone recommends. Avoid:

Being convinced by tax scam artists - tax scam promoters promise home based business deductions for expenditures that are not legitimately deductible.

Believing in erroneous justification to avoid federal income taxation.

Thinking that a home-based business automatically saves you tax dollars. If a legitimate business based in the taxpayer's home incurs an operating loss, then there is a tax savings.

Attempting to create the appearance of having a home-based business where none actually exists simply to claim otherwise nondeductible personal, living or family expenses from your taxes.

Confusing a hobby with a home business.

Let's first look at the hobby versus a home business closer.

Hobby Deductions

Regardless of what the taxpayer calls it, the IRS may classify the activity as a hobby.

A business may incur an operating loss during a tax year and this loss might offset income from other sources.

However, a loss from a hobby activity is not deductible and cannot offset other sources of income. The full amount of hobby revenue is included in a taxpayer's gross income. Hobby expenses may be deductible, but only up to the amount of hobby revenue. Simply put, a taxpayer can never have a hobby loss.

Is It a Business?

The distinction between a business and a hobby is critical to taxpayers. Make sure that you understand the factors the IRS uses to make a determination as you're researching what home based business deductions you can claim.

There are 9 relevant factors to distinguish between a business and a hobby:

1. The manner in which the taxpayer carries on the activity, e.g., maintainingaccurate books and records.
2. The expertise of the taxpayer or the taxpayer's advisors.
3. The time and effort expended by the taxpayer in operating the activity.
4. The expectation that assets used in the activity may appreciate in value.
5. The history of success of the taxpayer in other activities.
6. The history of income and losses in this activity.
7. The amount of occasional profits that are earned.
8. The financial status of the taxpayer. If this activity is the taxpayer's only source of income, the IRS is more inclined to consider the activity a business.
9. The elements of personal pleasure or recreation involved.

None of these factors is given more weight than another. Also, there is no formula to ensure classification as a business.

As stated in the Internal Revenue Bulletin 2004-12:

"Even if a taxpayer is engaged in a bona fide trade or business or is conducting activities from his home for the convenience of his employer, the taxpayer must satisfy the specific requirements of the Internal Revenue Code, such as those contained in sections 162 and 280A, to be entitled to deduct expenses related to those activities. Personal, living or family expenses are not deductible except as otherwise expressly provided by the Internal Revenue Code. I.R.C. � 262(a)."

Home-based businesses, and corresponding home based business deductions as apart of tax avoidance scams, are on the rise. In a consumer alert, the IRS warned that no matter how convincing the claims may appear in the marketing materials for these business schemes, nondeductible personal living expenses cannot be transformed into deductible business expenses.

So, are you wondering what home based business deductions you can specifically claim and what you should avoid claiming as deductions?

Avoid Claiming These as Deductions:

According to the IRS, the following are nondeductible personal expenses that are commonly claimed as home based business deductions in home-based business schemes. Don't fall for these:

Deducting the cost and operation of a personal residence.

Paying children a salary for services, such as answering telephones washing cars, or other tasks, and then deducting these costs.

Deducting education expenses from the salary wrongfully paid to children as employees.

Deducting excessive car and truck expenses when the vehicle has been used for both business and personal use.

Deducting personal furniture, home entertainment equipment, children's toys, and other household items.

Deducting personal travel, meals, and entertainment under the guise that "everyone is a potential client."

IRS Commissioner Charles O. Rossotti has said, "Each year, taxpayers reasonably search for deductions that will reduce the amount they owe. But they should resist the temptation of quick and easy schemes. Creating a bogus home business or other schemes crosses the line and puts the taxpayer on a path that will result in paying interest and penalties on top of the taxes they owe."

Okay. We've covered being careful to not take erroneous deductions. Now, let's look at what home based business deductions you can claim.

How to Determine What You Can Deduct:

First, the IRS offers additional details about home-based business deductions in Publication 587 (2005), Business Use of Your Home. You will find information about:

Qualifying for a Deduction

Figuring the Deduction

Deducting Expenses

Examples of necessary schedules

and more

Second, If you plan on deducting costs associated with you home business, keep good records. Avoid cutting corners here. File cancelled checks, receipts, and invoices to verify your expenses. For all expenses, keep careful records that separate business use from personal use.

Log every expense in an account book, a computer accounting program, or a diary. In addition, keep receipts or bills as documentation of your expenses.

Third, consult the experts. Decide who is going to do your taxes. I strongly recommend having a Certified Public Accountant do your takes for you. Avoid the temptation of saving money by doing your taxes yourself or using a bookkeeper.

There are several advantages in using a tax professional. They can save you time and frustration. They can spot deductions you might miss or not know about. Using a professional also saves you from being responsible for any errors that were made in the preparation, which could end up saving you thousands.

Since IRS rules are not crystal clear and each home setup is different, seek a tax professional by getting a recommendation from someone you trust.

In summary, take the deduction, but make sure you're entitled to it and make sure it's done right.

If you need more information, contact me. I am here to help.

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