How To Use A Home Based Business To Pay For College

COLLEGE LITERACY
ACADEMY
“Helping Families Pay The Cost Of A College Education”
A Family Guide On
Paying For
College
Financial Solutions For Families
Get The IRS To Help Pay
For College Expenses By
Starting A Home-Based
Business
Copyright 2004, 2005, 2006, 2007, 2008, 2009, 2010, 2011
By: Educational Literacy Center
All Rights Reserved
No part of this publication may be used or reproduced in any manner
whatsoever without written permission except in the case of brief
quotations embodied in critical articles and reviews.
For More Information Contact:
Chuck Moore, CCFC, CAMC, CAFC
502-721-8646
[email protected]
www.collegeliteracyacademy.com
This publication is general in nature and is not intended to give legal, accounting or investment
advice. Before incorporating any ideas in this publication the reader should
consult with their financial advisor or tax professional.
Some of this information is being provided by the Internal Revenue Service and
other tax resources or publication. The resource will be noted
How The IRS Can Help Pay For
Higher Educational Expenses
By Setting Up A
Home Based Business
An Instructional Book For College Bound Families
Most individuals do not realize or know that the Federal Financial Aid System is directly
affiliated with the Internal Revenue Service. The financial aid formula runs off parents’
and student’s income tax returns and income is the largest factor when it comes to
qualifying for financial aid, NOT ASSETS. Most middle and high income taxpayers will
NOT qualify for NEED-BASED financial aid at most state supported colleges and
universities. Therefore, proper tax planning is necessary. How you complete your
income tax returns could create what we call TAX SCHOLARSHIPS, which could be
more valuable than financial aid or scholarships.
The first thing you need to understand is there are TWO types of taxpayers:
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W-2 wage earners and
Self-employed or business owner
There are very few things a W-2 wage earner can do to reduce their taxes (other than
adjustments to income and itemized deductions).
However, if you have a home based business or are a self-employed business person,
there are thousands of ideas that can help reduce your taxes that can be used to help
pay for college, retirement or reduce debt.
Today it is almost impossible to raise a family and provide a college education to
children without both parents working. Of course, the more you make the more taxes
you will pay to the federal and state taxing authorities.
According to the Tax Foundation, “Individuals that have earned income and pays
taxes, will pay more in taxes than they pay for food, clothing, and shelter
combined.”
No one likes paying taxes. However, taxes must be paid in order to provide
NECESSARY services to the general society, such as defense, roads, and other items
that benefit the majority of the nation’s citizenry. Our tax system WAS NOT
established to be used as a social welfare system. However, according to the Tax
Foundation and other tax think tanks, most of our tax dollars are used to provide social
benefits (Social Security, Medicare, Medicaid, Welfare, college financial aid etc.).
Many individuals feel that these social benefits are necessary in our society today.
Regardless of your position, individuals should only pay their FAIR SHARE and no
more.
Since most individuals are W-2 wage earners there is very little you can do to control
the amount of taxes that you will pay. However, by establishing a home based
business, you can not only control how you pay taxes, you also can reduce the
taxation on the income you earn working your small business and depending how you
structure your business, you can potentially reduce the taxation on your W-2 wages as
well.
Before, I get into telling you how to start a home based business, I want to emphasize DO NOT start a business just to get the tax write-offs. The intent of starting a business
is the earn additional income to help pay for college, invest for retirement, or to reduce
debt. Always remember - the IRS doesn't tolerate scams and will shut you down if
they think your business is a fake.
WHAT IS THE DIFFERENCE BETWEEN A REAL AND FAKE
HOME BASED BUSINESS
According to Diane Kennedy (strategic tax planner and CPA www.taxloopholes.com) - A real home-based business will be one that acts like a
business. It often operates through a business structure, keeps separate books and
records, has separate bank accounts, prepares financial statements at least
once a year and above all, operates with the expectation of making a profit.
However, this doesn't mean your business MUST make a profit. In fact, your
business could lose money for years.
A real business is usually semi-formal. It's often been incorporated or formally
organized i.e., Doing Business As (DBA) and has established systems in place to
manage how services are provided, and how you get paid (i.e., work orders and
invoices).
There are administrative aspects to a real business, such as recordkeeping and
bookkeeping, and there are strict financial controls on where the money is deposited
and how it is withdrawn.
Real businesses also prepare proper financial statements.
She also defines what a fake home based business is - A fake home based
business only exists for one reason: to make a loss! It doesn't sell or do anything - it
exists as a method to move regular living expenses into the pre-tax dollar column. She
said, one so-called strategy advocated putting a filing cabinet into a room, and claiming
the home office deduction for that entire room.
A fake business may be something you do to make a little extra money, but it doesn't
necessarily exists to make a profit. Sewing baby cloths for your friends or acting as a
dog trainer could easily be a business without a profit motive. In both cases you are
doing something that you enjoy and would be doing it anyway.
She also says, a fake home based business does not keep any special records, and
probably don't have any special bookkeeping procedures in place. The money you
make gets deposited into your personal account and you spend your own money on
supplies and things you need to carry out your fake business. You don't prepare
financial statements, and simply declare the extra income on your tax return (at least I
hope you do).
If you are thinking about starting a home based business just for the tax benefits,
expect audits, fines, penalties and more.
It's okay to make a loss if you can show that you are TRYING to earn additional
income or trying to establish a business that can turn into a full time occupation.
WHAT ARE THE IRS’s GUIDELINES OF HAVING A LEGITIMATE
HOME BASED BUSINESS
The IRS has outlined nine requirements that everyone must go by in order to have a
legitimate business . This does not mean you have to meet ALL nine at the same time.
The most important requirements are the first two. As long as you follow these steps,
you would have a legitimate business and are entitled to all of the tax savings and
deductions that are available for all businesses.
The most important requirement of the nine steps is:
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Your business must be organized and operated with the intention of
making a profit.
The key word in this statement is INTENTION. Making a profit is NOT an IRS
requirement. The IRS knows many new businesses lose money for the first three to
five years, and sometimes for much longer periods of time.
The next most important factor in proving you have a true business is:
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You carry on your activities in a businesslike manner.
This means keeping records that is in line with what is called generally accepted
accounting principles, or GAAP. Also you need to keep the business finances
(income, expenses, etc.) separate from your personal finances.
Important Note: Do not operate your business through your personal checking
account and make sure your keep ALL business related receipts separate from your
personal receipts. Your business records should have things like copies of all
invoices, records of your sales, receipts for all of the merchandise and inventory
purchases you have made over the year, as well as receipts for other things, like
shipping supplies, postage, and so on.
This is not as complicated as it sounds and only takes a few minutes a day. Just make
sure you document your business expenses.
The other seven steps are:
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You depend on income from the activity for your livelihood.
For example, your main objective is to earn as much income as possible and the
money that you earn is used to meet your living expenses. Or, you may have cut back
your regular employment hours to part-time, or even left your job altogether and rely
solely on your business income. The income from your business DOES NOT have to
be your primary source of earnings.
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Your losses are due to circumstances beyond your control (or are
normal in the startup phase of your type of business).
It is okay for you to make a loss, as long as you document why i.e., non-paying
customers or fraud, cost of materials increased unexpectedly, etc. and you can show
that those types of losses are normal for your type of business, especially in the
beginning.
It is also helpful to learn what others in your business or similar business have
experienced in losses of profits.
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You change your methods of operation in an attempt to improve
profitability.
For Example: If you provide a service and are paid after the service is provided and a
few of your customers do not pay you, you need to change the way your are getting
paid. If you are consistently losing money and not making a profit, do something to
change the non-profitability like purchasing business books, attending seminars or
marketing courses, and so on. You can also talk to business consultants, your CPA, or
other experts about ways to make your business more profitable.
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You or your advisors, have the knowledge needed to carry on the
activity as a successful business.
If you are brand new in your business, it does not make any sense to take advice from
someone who has never operated your kind of business (or any other kind of business) before. Someone needs to demonstrate some knowledge of your business!
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You were successful in making a profit in similar activities in the past.
This does not necessarily mean you have run a business before - but if you have tried
other business opportunities, it is helpful to be able to show that you have made a
profit in the past.
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The activity makes a profit in some years (how much profit it makes is
also considered).
Your business has made a profit in at least some of the years it has been operating
and those profits have been large enough to make it economical to continue the
business. This is often a tough step to fill in the early years, but this step is not as
important in the early years as it becomes later on.
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You can expect to make a future profit from the business and from
appreciation of any assets used in the activity.
This is where putting your business profits to work for you comes in handy, especially if
you can show that you're using your profits to invest in real estate, hiring more
employees, purchasing more equipment, providing employee benefits and so on.
Now you are not always going to meet all nine of these steps, and that is okay. Again,
it's the first two steps that are critical.
UNDERSTANDING THE ROLE OF THE IRS
Before we get into a step-by-step process of starting a home base business you need
to understand the purpose and mission of the IRS.
According to IRS statement of organization and functions, 39 Fed. Reg, 11,572,
1974, “The purpose of the IRS is to collect the proper amount of tax revenue at
the least cost to the public and in a manner that warrants the highest degree of
public confidence in our integrity, efficiency and fairness. To achieve that
purpose, we will encourage and achieve the highest degree of voluntary
compliance in accordance with the tax laws and regulations. We will advise the
public of their rights and responsibilities, determine the extent of compliance
and the causes of noncompliance. We will do all things needed for the proper
administration and enforcement of the tax laws and continually search and
implement new, more efficient and effective ways of accomplishing our Mission.”
Let’s interpret what the above statement is saying. It is very simple. The IRS is a
compliance division of our Federal Government. It’s main purpose is to follow the
laws that were passed by Congress and makes sure everyone is following the laws
and regulations that Congress has written. Therefore, do not get upset with the IRS
if you are paying more taxes than you feel you should - be upset with your
elected officials that you put in Congress. The IRS is NOT the bad guy!
STARTING A HOME BASED BUSINESS
STEP ONE - Decide On What You Want To Do
The first thing you need to do is decide what type of business you want to start. Many
of you may not know what type of business that you can establish. However, there are
several things that you can do. Below are a few examples:
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Consulting (what do you do for a living - turn it into a small business)
Teach classes on how to do things
Get into a multi-level marketing program
Write a book on what you know well and sell it on E-bay
Tutor students that are having trouble with a subject matter
Start a lawn care, gutter cleaning, snow removal service and hire your kids to
do the work
Become a proof reader
Become a seminar coordinator (solicit people to come to another persons
seminars)
Develop websites for churches or other business
And the list can go on and on
The key is to do something that you know and can do it well.
Once you know what you want to do as a business, the next thing is to set up the
business structure.
STEP TWO - Decide What Type Of Business Structure You Want To Use
There are several business structures you can establish. You can operate your
business as a sole-proprietor, partnership, or you can incorporate your business as a
LLC, S or C corporation. Each of these structures have their advantages and
disadvantages. Many of you may not know which structure to use. Therefore, I would
recommend to check out a book from the library on business structures or buy a book
for reference. One book I highly recommend is “Lower Your Taxes Big Time”, by
Sandy Botkin, CPA, Esq. His is a former IRS Attorney and Senior Tax Law Specialist.
The book is a wealth of knowledge on developing a home based business. Of course,
you can always talk to your CPA or tax specialist. Some of the ideas in this publication
are from Sandy Botkin’s book.
Most of you will start your business as a sole-proprietor. This is the least costly and
easy to set up. Normally, all you have to do is set up a business checking account and
have the account listed as DBA - example: John Doe DBA (doing business as)
Consulting Services of Greater Louisville.
Note: Check with you local taxing authority to make sure you do not have to have a
license to operate your business.
STEP THREE - Develop A Business Plan
It is always a good idea to develop a business plan to help you stay focused and keep
you business on track. The plan does not have to be filled with legal terms and
verbiage that is hard to understand. Below are a few things that should be in your
business plan:
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Name and location of your business
Contact Information
How the business is structured (sole-proprietor, partnerships, LLC, S or C
Corporation, etc)
Brief overview of what the business does
Overview of your target market
Projected revenue for the first, second and third years
Do you plan on hiring employees (family members, children, out-side contractors, etc.)
Projected cost of running your business for the first, second and third years
List of professional that you can contact to help grow your business
And any other items that you feel is important to you and your business
Keep in mind your business plan does not have to be a complicated legal form and the
length of the plan could be a few pages. Once your business plan is written make sure
to file the plan in your business filing system.
STEP FOUR - Run Your Business Like A Business
Once the first four steps have been completed, you need to start operating your
business like a business. First, make yourself look like your are in business. Here are
a few suggestions Sandy Botkin gives:
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Print up some business cards. You do not need to have them professionally
done. You can make and print them on your own computer.
Develop your letterhead. Once again you can do this yourself.
Develop flyers that can be given out or flyers that you can leave at different
locations in your target area.
Develop a website. You can do this for as little as $20 a month. One
resource to check out is Homestead SiteBuilder. They provide self developed
websites that look professional and is very reasonably priced. If you have
children that are computer literate, hire them to develop and maintain the site
for you and deduct the cost of paying them off your taxes. Once the site is
up and running let people know about the site.
Run Ads. Running an Ad in the local newspaper could be very expensive.
Therefore, look at other areas that do not cost an arm and a leg. Such as
school athletic programs, church and other non-profit bulletins, etc.
STEP FIVE - Let People Know You Are In Business
In order for you to make a profit you need customers. Therefore, let people know you
are in business.
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Contact your local paper and let them know you are a new business in the
area.
Contact centers of influence that you know and let them know about your
new business.
Hand out your business card to as many people as possible.
Leave your flyers at local businesses that you conduct business with on a
regular basis.
Contact local radio and TV stations to see if you could come on their morning
new shows to talk about your business.
Join a small business group.
Contact other business that you can work with in order to help promote their
business as will as yours. This is a win - win situation.
Develop a series of E-books that covers items of interest about what you do
and email them to your potential clients or centers of influence.
These five steps are important when operating your new business. If you will notice all
of the steps we just went over covers the first two requirements of proving to the IRS
that you have a real legitimate business and your are doing the right things in order to
make a profit. This is the business’s main intent.
Now that you know how to set up your business let’s look at some of the business
deductions you can legally deduct against your business income and depending on
how you structure your business, against your W-2 wages.
Keep in mind, the deduction list in this publication are approved by the IRS and
are general in nature. The intent of listing these deductions is not intended to
give legal, accounting or investment advise and before implementing any of the
items covered you should talk to your tax specialist or CPA to make sure the
deduction can be taken. In order to get more detailed information, check out
Sandy Botkin’s Book “How To Lower Your Taxes Big Time”.
Entertainment Costs
Many small business owners will entertain potential clients in order to promote their
business. Prior to 1987 100% of any entertainment cost for you or a prospect was tax
deductible. However, due to tax simplification laws, your entertainment deductions are
normally limited to 50% - Internal Revenue Code (IRC hereafter) 274(n)(1).
There are some exceptions to the 50% rule so check with your tax professional or
CPA.
Travel Expenses Away From Home
How does the IRS define business travel? Business travel is when your are traveling
from home, overnight, or for a period of time sufficient to require sleep - U.S. vs.
Correll, 389 U.S. 299 (1967), Revenue Ruling 54-407, 1954-2 CB 75, superseded in
part by Revenue Ruling 75-170, 1975-1 C.B. 60.
If you meet the above definition, you can deduct, as business expenses, the cost of
meals and transpiration. If you do not sleep over night you normally can only deduct
your transpiration costs - K. Waters, 12 TC 414, Dec. 16,873, C.M. Scott, 110 F.Supp.
819.
There is some confusion between transportation expenses and on-the-road expenses.
According to the IRS transportation cost are costs that is incurred in getting to and from
your destination - Section 162(a)(2) and 62(2)(B) of the IRC, section 1.162-2 of the
ITR. For example: the actual cost of your airfare or car costs while going to your
destination, would come under this category. Now on-the-road expenses include
expenses necessary to sustain life while on the trip. Example: all expenses paid for
lodging, meals, laundry, dry cleaning and other necessary expenses.
Can you deduct expenses incurred for you spouse while on a business trip? Under
Giordano vs. Commissioner, 36 T.C.M. 430 (1977); Howard vs. Commissioner, 41
T.C.M. 1554 (1981) Section 1.162-1 of the ITR, you can deduct your spouses
expenses as long as the expenses incurred has a legitimate business reason. In order
to deduct your spouse’s expenses you will have to meet the following:
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Your spouse must be an employee of your business and
Your spouse must be traveling for a bona fide business purpose and
The expenses would otherwise be deductible
You can even deduct business travel and take a vacation at the same time. Check
with your CPA or tax advisors for more information.
Income Shifting and Income Splitting Can Save You
Thousands Of Dollars In Taxes
Any one that is married and has children can benefit greatly by shifting or splitting
income. One of the biggest benefits of hiring your spouse in your business is putting
you into a situation to deduct medical expenses that would normally not be deductible,
unless the medical expenses are over 7.5% of your adjusted gross income.
If you structure your business as a C-Corporation or a sole-proprietor and hire your
spouse you can set up a medical reimbursement plan and avoid the medical expense
threshold of the 7.5%. - Section 1.105-5 of the ITR and IRS letter Ruling 9409006,
ISP Coordinated Issue Paper (UIC-162.35.22) see Revenue Ruling 71-588, 1971-2
CB 91.
Under Section 105 you can set up a medical reimbursement plan even if you only have
one employee. If you hire your spouse, you can cover your family and yourself under
the self-insured medical reimbursement plan - Section 1.105-5 of the ITR and IRS
letter Ruling 9409006, ISP Coordinated Issue Paper (UIC-162.35.22) see Revenue
Ruling 71-588, 1971-2 CB 91. If you are a sole-proprietor, you can pay for medical
expenses that are not covered by your insurance policy. You could deduct expenses
such as coinsurance, braces and dental expenses, mileage to and from the doctor,
preexisting conditions, routine physicals, psychiatric, and nontraditional medicine such
as acupuncture, chiropractic, etc. The medical reimbursement plan that is set up
would reimburse you and your family for these out-of-pocket expenses TAX FREE.
Check with your CPA or Tax Advisor for more information.
Hire Your Children In Your Business
If you have children that will be going to college, you CANNOT deduct the cost of this
expense. You may be able to qualify for the educational tax credits and deductions,
but that is all. If you provide a car or pay for your daughter’s wedding, you cannot
deduct these expenses either.
However, there is a way to deduct the equivalent expenses as a business deduction.
In order to do this is to hire your children in your business. When the children are paid
for legitimate work performed they then can use this money to pay for college, buy a
car, or pay for their wedding. If you are structured as a sole-proprietor or LLC (Limited
Liability Corporation) and the child or children are under the age of 18 you DO NOT
have to withhold Social Security Payment and unemployment taxes on their wages Section 3121(b)(3)(A) and 3306 c(5), Revenue Ruling 2000-45, IRB 2000-41. Once
your child is age 18 you must withhold Social Security and unemployment taxes. If
your business is incorporated you must withhold Social Security and federal
unemployment taxes on wages that are paid to the child regardless of the age of the
child.
What can you pay your child for working in your business? The IRS considers nine
factors that they use to see if the wages being paid are reasonable - IRS Publication
535, Chapter 2. Below is an overview of the nine factors:
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Duties performed
Volume of work
Type and amount of responsibility
Complexity of work
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Amount of time required for work
General cost of living in the area
Ability and achievements of the employee
Comparison of amount of salary with amount of business income
Pay history of the employee
A rule of thumb you can go by is pay a salary to your child in the amount that you
would normally pay a unrelated employee doing the same type of work Section1.167-7 (b)(3) of the ITR, Automotive Investment Development, Inc. vs.
Commissioner, 66 TCM 57 (1993), Giles Industry, Inc. vs. United State, 496 F.2d
566 (ct. Cl. 1974). It is important to pay your child a reasonable wage based on the
child’s ability and experience to do the job. The more experience the child has the
more you can pay them. The more documentation you have to justify the wages you
pay your child the better off you will be.
A good way to find out how much to pay the child is to compare what it would cost you
if you had to hire someone other than the child to perform the work. Example: If you
wanted to hire your 14 year-old to do filing and bookkeeping for you, make a call to a
temporary agency and ask them to quote you a cost of performing this work. If they tell
you it will cost you $15 an hour, pay your child $13 an hour. Note: Save the quote
and put it in your business files.
It is also important to keep a log that proves the work was actually performed. Below
are documentations that you need to log:
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The date work was performed
A description of the work performed
The hours worked
Make sure you pay your child with a company check and have the child deposit the
check in their OWN checking account.
As of the present, you can pay your child up to $5,800 (2011), still claim the child as a
dependent and the child will NOT have to pay any income taxes as long as their total
income from all sources does not exceed $5,800 (2011). You can pay your child more
than the $5,800 and still have all the income tax free. You can pay the child $7,800
and have them contribute to an IRA ($2,000) at the end of the year. The IRA can be
used to help pay for college expenses without paying a 10% penalty prior to age 59
1/2. Check with your CPA or Tax Professional for more information.
Below is a sample of a business services and wage sheet that you can use.
Month: September
Child’s Name: Amber Morris
Day of Week
(Mon, Tues, etc)
Date
Description of Tasks Performed
Monday
Tuesday
Thursday
Saturday
Saturday
9
10
12
14
14
Filing, mailing, and empty trash
Addressed envelopes for mailing
Typed business letters
Clean office and restroom
Sent mailing out, filings, empty trash
Hours
Worked
4
2
3
3
2
Total Hours Worked
14
Hourly wage
$8 an hour
Total Wages Paid with Check No. 2345
$112.00
Deducting Business Mileage
There are two ways to deduct car expenses when a car is used for business:
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The actual expense - the actual expense allows you to deduct the actual
expenses you pay for operating the car when it is used for business, i.e. gas,
oil, depreciation, insurance, repairs, interest on car loan, taxes, etc.
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IRS Standard Mileage Rate - the standard mileage is given in ¢ per mile
driven. For example: you could receive 50.3¢ per mile or 51¢ per mile. The ¢
per mile will vary depending on the cost of gas and operating your
automobile and is set by the IRS on a regular basis. For example: If you
drive your car for business use for 10,000 a year, you would take the 10,000
miles X ¢ per mile to come up with the amount of money you can deduct
(10,000 X 51¢ per mile = $5,100 that is deductible). Part of the Standard Mileage Rate covers the depreciation of the car/truck and part is allowed for actual cost of operating your vehicle.
Which method you should use depends on which method will give you the larger tax
deduction, so check with your CPA or tax advisor.
Deducting business miles can be a great benefit when you have a home based
business and your principal place of business is your home office. According to the
IRS commuting miles from your home to your principal place of business is NOT tax
deductible mileages, IRS Publication 463. However, if your principal place of
business is your home office then all business stops ARE tax deductible.
For example: If your principal place of business is your home office and you leave
this location to go to the post office to mail post cards or flyers, the miles driven are tax
deductible, Revenue Ruling 90-23, I.R.B. 1990-11.
According to Diane Kennedy, CPA (Owner of TaxLoopholes.com), if you have a
legal home based business and you are also a W-2 wage earner at a job that provides
most of your annual income, your first business stop could be the distance from your
bedroom to your office in your home. Since your second job location is where you
earn your W-2 wages, it is looked upon as your second business stop and the mileage
from your home office to this location is tax deductible.
If you have a home office and an office at a different location, the commute from your
office at home and your principal office is NOT tax deductible.
When you complete your taxes and plan on taking business mile deduction, you will
find the IRS will want you to separate the miles that you have driven during the year
into four different categories:
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Total Miles Driven
Total Business Miles Driven
Total Commuting Miles Driven and
Other Personal Miles Driven (non-commuting miles)
In order for you to deduct business miles driven, you must show evidence to support
the miles driven and is the evidence in writing, IRS Form 2106 see sections 1.274-T
(d)(2)(1) of the ITR and Form 4562.
There are two methods of recording business miles that the IRS will accept:
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Daily Log - writing down the actual miles driven for business and personal
use in a tax diary or tax organizer. This method is the most complicated way
of documenting mileages.
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90 Day Log - according to the information from Sandy Botkin’s book and the
IRS, The IRS regulations allows a mileage record for a representative portion
of the year to substantiate business miles driven during the year, Sec 1.2745T(c)(3) of the ITR.
If you use the 90 Day Log method, you would select three consecutive months i.e.
March, April, and May, and log the actual business and personal miles driven during
this time frame. For example: If you drove 10,000 miles during the 3 months and
8,000 was business miles and 2,000 were personal miles, you would be able to deduct
80% of your car expenses or 80% of your total yearly mileage using the standard
mileage rate, Sec 1.274-5T(c)(3)(ii) of the ITR. This is by far the simplest and less
time consuming method.
Establishing An Office In Your Home
Home Office Rules
Normally the only expenses you can deduct that are related to your home is the
interest you pay on your mortgage and the property taxes that is owed each year, Section 280(A)(a) of the IRC. However, if you have a home office established in your
home or in an unattached dwelling (building, garage, shed, etc) you can deduct other
cost items other than mortgage interest and property taxes.
You can deduct business use expenses of certain costs dealing with your home as
long is the area is EXCLUSIVELY used for business purposes. Below are the tax laws
that must be followed:
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The home office is the principal place of business
The home office is used to meet clients or customers in the normal course of
doing business or
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In order to take home office deductions you must establish an area in your home that
is EXCLUSIVELY used for business purposes.
The first important test you need to meet is where do you conduct the most important
functions for your business. Normally the location is where you meet clients or
customers or where you render your services. This ruling went all the way to the
Supreme Court in order to clarify the rules in deductions for a home office,
Commissioner vs. Soliman, 506 U.S. 168 (1993).
This case eliminated many home based business owner from deducting home office
deductions. However, in 1999 Congress passed an exception to the Soliman case.
The exception that was passed relaxed the rules for home office deductions. Below
are the exceptions to the Soliman case:
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The office is used to conduct administrative or management activities of
your trade or business and
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activities.
Therefore, if you meet clients, customers, read business materials, prepare billings,
listen to business taps, call potential customers for meetings, or any administrative
activities, you can deduct home office expenses, Section 280(A)(C)(1) of the IRC.
What Deductions Are Available When You Have
A Home Office
There are three categories that you need to know when it come to home office
deductions:
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Expenses that are DIRECTLY related to the home office portion, Section 1.280A2(i)(5) of the IRC. - Example: painting your office, repairs, or other maintenance
functions preformed that is directly related to the space are 100% tax deductible.
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Expenses that don’t benefit the home office directly or indirectly. Example:
Painting another room, plumbing repairs of a bathroom or lawn care if you DO
NOT meet customers or clients at your home office are NOT tax deductible, IRS
Publication 587.
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Indirect expenses related to the home in general. This relates to depreciation,
home security systems, utilities, repairs, painting of the out-side of the home, etc.
These deductions can be taken based on the PERCENTAGE of the home office in
relationship to the total square footage of the home. Example: If the square
footage of your home office is 5% of the total square footage of the home, you can
deduct 5% of these costs as business deductions.
It is important to make sure that the home office expenses will stand up to an IRS
audit. Below are a few suggestion that will help audit proof you deductions. All these
items should be filed in your business filing system:
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Take a picture of your home office
Figure the square footage of your office space
Display your address and phone number on your business cards and flyers
If you have customers come to your office have them sign a logbook
Keep records of the time you spend in your home office
Equipment and Furniture That Is Used In Your Business
Equipment and furniture can be deducted based on the percentage you use them in
your business. Also, you DO NOT need to claim a home office deduction in order to
deduct your furniture, Section 280 of the IRC and Muline vs. Commissioner, T.C.
Memo 1996-320.
Everything that you use in your home office can be depreciated over a certain time
period that you use them. However, you also can expense the items off your taxes in
the very first year that you use it in your business. This is done by incorporating
Section 179 expense election (check with your CPA or tax advisor for limits).
There are four other ways to deduct furniture and equipments, below are the methods:
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MACRS (accelerated method of depreciation)
Slow Straight-Line of depreciation
30% Expense Election
50% Expense Election
Check with your CPA or tax advisor before electing which depreciation method
is best for your business purpose.
Closing Comments
Starting a home based business can save you thousands of dollars in income
taxes as long as the business is set up legally, morally and ethically. If you want to pay
less tax and earn additional tax-free money, you need to get out of the W-2 wage
earner’s trap.
You need to look at paying taxes in a new way. United State Treasury Secretary, Paul
O’Neill said at one time, “A fine is a tax for doing something wrong. A tax is a
fine for doing something right.” You will never pay less income tax as long as you
are a W-2 wage earner. Starting some type of home base business can be an
opportunity to grow your income and at the same time keep your taxes down to a
minimum.
Senator Bill Bradley in 1984 said, “Our income tax system is overly complex. It
distorts investment decisions and encourages people to put money into
schemes to reduce their tax bills, instead of into enterprises to create jobs and
help our economy grow.”
This quote cannot be more truer, especially in today’s economic climate. By setting up
a home based business you can create additional income and reduce your taxes and
use the additional money to help pay for your children’s college education.
If you need help with college affordability or help with general money management
issues, give me a call and let’s talk.