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Legalities and Tax advantages in a home business
LEGALITIES & TAX ADVANTAGES IN A HOME BUSINESS
Every year, several thousand people develop an interest in "going
into business." Many of these people have an idea, a product or a
service they hope to promote into an income producing business which
they can operate from their own homes.
If you are one of these people, here are some practical thoughts to
consider before hanging out the "Open-for-Business" sign.
In areas zoned "Residential Only," your proposed business could be
illegal. In many areas, zoning restrictions rule out home
businesses involving the coming and going of many customers, clients
or employees. Many businesses that sell or even store any thing for
sale on the premises also fall into this category.
Be sure to check with your local zoning office to see how the
ordinances in your particular area may affect your business plans.
You may need a special permit to operate your business from your
home; and you may find that making small changes in your plan will
put you into the position of meeting zoning standards.
Many communities grant home occupation permits for businesses that
involve typing, sewing and teaching, but turn thumbs down on
requests from photographers, interior decorators and
home-improve-ment businesses to be run from the home. And often,
even if you are permitted to use your home for a given business,
there will be restrictions that you may need to take into
consideration. By all means, work with your zoning people, and save
yourself time, trouble and dollars.
One of the requirements imposed might be off-street parking for your
customers or patrons. And, signs are generally forbidden in
residential districts. If you teach, there is almost always a limit
on the number of students you may have at any one time.
Obtaining zoning approval for your business, then, could be as
simple as filling out an application, or it could involve a public
hearing. The important points the zoning officials will consider
will center around how your business will affect the neighborhood.
Will it increase the traffic noticeably on your street? Will there
be a substantial in crease in noise? And how will your neighbors
feel about this business alongside their homes?
To repeat, check into the zoning restrictions, and then check again
to determine if you will need a city license. If you're selling
something, you may need a vendor's license, and be required to
collect sales taxes on your transactions. The sales tax requirement
would result in the need for careful record keeping.
Licensing can be an involved process, and depending upon the type of
business, it could even involve the inspection of your home to
determine if it meets with local health and building and fire codes.
Should this be the case, you will need to bring your facilities up
to the local standards. Usually this will involve some simple
repairs or adjustments that you can either do personally, or hire
out to a handyman at a nominal cost.
Still more items to consider: Will your homeowner's insurance cover
the property and liability involved in your new business? This must
definitely be resolved, so be sure to talk it over with your
Tax deductions, which were once one of the beauties of engaging in a
home business, are not what they once were. To be eligible for
business related deductions today, you must use that part of your
home claimed exclusively and regularly as either the principal
location of your business, or the place reserved to meet patients,
clients or customers.
An interesting case in point: If you use your den or a spare bedroom
as the principal place of business, working there from 8:00 to 5:00
every day, but permit your children to watch TV in that room during
the evening hours, the IRS dictates that you cannot claim a
deduction for that room as your office or place of business.
There are, however, a couple of exceptions we will note to the
"exclusive use" rule. One is the storage of inventory in your home,
where your home is the location of your trade or business, and
approval for your business, then, could be as your trade or business
is the selling of products at retail or wholesale. According to the
IRS, such storage space must be used on a regular basis, and be a
separately identifiable space.
Another exception applies to day care services that are provided for
children, the elderly, or physically or mentally handicapped. This
exception applies only if the owner of the facility complies with
the state laws for licensing.
To be eligible for business deductions, your business must be an
activity undertaken with the intent of making a profit. It's
presumed you meet this requirement if your business makes a profit
in any two years of a five-year period.
Once you are this far along, you can deduct business expenses such
as supplies, subscriptions to professional journals, and an
allowance for the business use of your car or truck. You can also
claim deductions for home related business expenses such as
utilities, and in some cases, even a new paint job for your home.
The IRS is going to treat the part of your home you use for business
as though it were a separate piece of property. This means that
you'll have to keep good records and take care not to mix business
and personal matters. No specific method of record keeping is
required, but your records must clearly justify any deductions you
You can begin by calculating what percentage of the house is used
for business, either by number of rooms or by area in square
footage. Thus, if you use one of five rooms for your business, the
business portion is 20 percent. If you run your business out of a
room that's 10 by 12 feet, and the total area of your home is 1,200
square feet, the business-space factor is 10 percent.
An extra computation is required if your business is a home day care
center. This is one of the exempted activities in which the
exclusive use rule doesn't apply. Check with your tax preparer and
the IRS for an exact determination.
If you're a renter, you can deduct the part of your rent which is
attributable to the business share of your house or apartment.
Homeowners can take a deduction based on the depreciation of the
business portion of their house.
There is a limit to the amount you can deduct. This is the amount
equal to the gross income generated by the business, minus those
home expenses you could deduct even if you weren't operating a
business from your home. As an example, real estate taxes and
mortgage interest are deductible regardless of any business activity
in your home, so you must subtract from your business' gross income
the percentage that's allocable to the business portion of your
home. You thus arrive at the maximum amount for home-related
If you are self-employed, you claim your business deductions on
Schedule C, Profit (or Loss) for Business or Profession. The IRS
emphasizes that claiming business-at-home deductions does not
automatically trigger an audit of your tax return. Even so, it is
always wise to keep meticulously within the proper guidelines, and
of course keep detailed records if you claim business related
expenses when you are working out of your home. You should discuss
this aspect of your operation with your tax preparer or a person
qualified in the field of small business tax requirements.
If your business earnings aren't subject to withholding tax, and
your estimated federal taxes are $100 or more, you'll probably be
filing a Declaration of Estimated Tax, Form 1040-ES. To complete
this form, you will have to estimate your income for the coming year
and also make a computation of the income tax and self-employment
tax you will owe. The self-employment taxes pay for Social Security
If you have a salaried job covered by Social Security, the
self-employment tax applies only to the amount of your home business
income that, when added to your salary, reaches the current ceiling.
When you file your Form 1040-ES, which is due April 15, you must
make the first of four equal installment payments on your estimated
Another good way to trim your taxes is by setting up a Keogh plan or
an Individual Retirement Account. With either of these, you can
shelter some of your home business income from taxes by investing it
for your retirement.
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