Tax Aspects of A Home Business

I. What Distinguishes a Business From a Hobby?

While some taxpayers conduct very successful businesses out of their homes many home based enterprises are part time or start up ventures which may not show a profit every year on the owner's tax return. An important question in this situation is whether the individual may treat the enterprise as a business on her tax return, or whether she may deduct her business expenses in her income tax calcualtion.

If the Internal Revenue Service does not believe an entrepreneur is treating the operation as a business the government might consider it a hobby.

The government will only take this position, if they have something to gain by it, in other words, if they can deny deductions on the tax returns. Income from an activity will always be taxable whether the taxpayer treats it as a serious business or not.

Since even successful enterprises often lose money when they are starting up qualifying as a business for tax purposes becomes an important consideration.

An activity is presumed to be run for a profit if it produces income in three out of five consecutive years. The business owner should not give up though merely because he fails to meet this test. Facts and circumstances can still convince the tax authorities that the activity is a business rather than a hobby (i.e. the taxpayer operates the venture like a serious business, advertising, keeping books, etc.)

II. Deduction for Using Your Home To Run a Business.

To qualify for a home office deduction on your tax return you must meet one of five tests:

1) The space must be used exclusively as the principal place of the business. Whether the home will qualify as the principal place of a business depends on the importance of the activities performed there and the amount of time spent there. Administrative or management activities can qualify the home as the principal place of business, but only if the taxpayer has no other place where he conducts administrative or management activities for that business. Thus a plumber who works solely out of his truck and does his paper work in his home might qualify for the deduction. However, if he rents an office for the plumbing business and still does his paper work at home because he finds it more convenient he will not qualify.

 2) The space is used exclusively to meet with customers.

3) The space is used regularly to store products for sale.

4) The space is used to provide child care services.

5) The space is a separate structure from the taxpayer's residence and is used exclusively for business. e.g. an apartment over a garage which is detached from the taxpayer's residence.

A taxpayer computes the deduction for a home office by figuring the portion of her home used for the business and taking an appropriate percentage of the costs of maintaining the home; including:

1) Rent (or depreciation of building, if taxpayer owns the home.)

2) Utilities.

3) Taxes.

4) Insurance.

5) Other costs of the home.

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For more information on income taxation contact our office for a free consultation

Patrick J Hart

Attorney at Law

728 Florsheim Drive

Libertyville, Illinois 60048

Phone: 847 680-7240