Operating a business from your home may have significant tax advantages for your family, depending upon your circumstances. If the business loses money year after year, however, some of those advantages may disappear.
First, consider a few typical home-based business deductions:
Depreciation of your home
When running a business from home, you are eligible to depreciate a portion of your home - the portion devoted exclusively to the business - on your tax return. If you rent, you may be able to allocate a portion of your rent to the business, thus making it tax-deductible, as well. If you depreciate your home office for business purposes, when you sell your home, the sale - which would otherwise be tax free - could trigger a capital gain subject to tax. The beauty of the depreciation expense deduction is that you don't pay a dime for this expense. Simply allocating a portion of your home exclusively to the business creates an eligible deduction for which you have no cash outlay.
Mileage deduction
for business purposes
Driving back and forth to work, even if you own the business, is considered commuting and is not deductible. If you have a home-based office, you can generally deduct the miles you put on your car driving around for business purposes. If you own an economical car, the deduction is likely to exceed the expense of driving the car.
Cell phone
If you must use your cell phone for work, you can generally deduct that expense - even if you also use it for personal reasons.
Other customary business expenses
Some other household expenses, like relevant magazine subscriptions and newspaper subscriptions may also relate to the business and you may be able to deduct those, as well.
As you can see, simply creating a home-based business can allow you to create some tax deductions that you would not have as an employee of someone else's business - or even of your own business that is not home-based. There is one big caveat to these deductions - and some smaller ones:
Hobby loss rule
The IRS does not allow you to deduct losses on businesses it deems a hobby. This rule is subjective, but generally, if you have a small, home-based business that never makes a profit, the IRS will likely make the case that it is a hobby and the losses are not deductible from your other income. Furthermore, the appeal of a home-based business that generates a loss goes away if you have no other income from which to deduct the losses.
Scale
For a typical home-based business, there would be less than $10,000 per year of expenses associated with it being at home. Otherwise, if your business generates a large profit, the home-based business expenses may not make much of a difference. You might much rather have the business move out of your house than to keep deducting a few, modest expenses.
Social Security and Medicare Taxes
When you work for someone else, you pay only half of the Social Security and Medicare Taxes - your employer pays the other half. When you work for yourself, you pay both halves. So, if you create a home-based business that generates $50,000 per year in profits as an alternative to a $50,000 per year job, you'll actually pay more in taxes on the $50,000 profit than you did on the $50,000 job.
If you are excited to start a business and will operate it out of your home until it achieves a certain scale, be aware that in those early years when losses are likely, they can help to reduce the taxes you pay on your income. If you wish to create a business simply for the purpose of creating a tax advantage, you are not likely to come out ahead in that game.
Be sure to consult a CPA before filing your tax return or launching a home-based business.
