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Home Business Deductions

What Does the IRS Think Of YOUR Home Business?

I’m sure most of you have heard “Treat your business like a business and it will pay you like a business. Treat your business like a hobby and it will cost you like a hobby.” or something similar. In order for your home business to be successful, you need to treat it as a business and not a hobby.

However, while this is important in terms of your earning potential, equally important is how the Internal Revenue Service (IRS) views your business.  In the U.S., the tax advantages alone can make having a home-based business the single best financial move you could ever make but ONLY when the IRS determines that you are actually running a business engaged in for profit.  If they think it’s a hobby and not a business engaged in for profit, your ability to deduct expenses is limited.

Are you treating your business like a business or like a hobby?   How do you know?

A good starting point is to ask yourself the following questions and making sure your activities pass the test.  These following 9 factors, although not all inclusive, will help you to determine whether your activity is an activity engaged in for profit or a hobby as determined by the IRS:

1. Manner in which the taxpayer carries on the activity (keep books, maintain an office, etc.)
2. The expertise of the taxpayer or his advisors
3. The time and effort expended by the taxpayer in carrying on the activity
4. Expectation that assets used in activity may appreciate in value
5. The success of the taxpayer in carrying on other similar or dissimilar activities
6. The taxpayer’s history of income or losses with respect to the activity
7. The amount of occasional profits, if any, which are earned
8. The financial status of the taxpayer
9. Elements of personal pleasure or recreation

Many home business owners fear that their returns will be audited by the IRS.  However, too often the thought is only in terms of deductions so it’s important to understand this additional piece.  If selected for audit, the IRS may also be making a factual determination whether your activity is engaged in for profit.  Therefore, it is to your advantage to be proactive by ensuring that your activity supports and demonstrates that it is, indeed, a trade or business engaged in for profit.  Otherwise, your deductions could be disallowed so this is a great place to start.

*Disclaimer: This article is meant for informational and discussion purposes ONLY.  It is not intended in any way to be construed as tax advice.  For expert advice, seek out the appropriate professional who can represent your interests.

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Laura Paulson

Laura Paulson

Laura is a marketer building assets that spin off passive, residual income.
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24 Responses

  1. I’ve been running my own side business since 2007 and one of the most important things that you can do to keep the IRS off your back is just to be totally honest with your business dealings and you should be OK. Your article definitely supports that philosophy.

  2. An excellent list and it applies in Canada too. Except of course the references to the IRS.

    The was one of the reasons I decided to start my own business, because of the tax benefits. Of course it’s not my #1 reason but it is an excellent side benefit. 🙂

    Having just come from my accountants office yesterday, I have even more proof.

  3. Hey, really great post, thoroughly enjoyed the read. We do our best to make sure all our records are kept up to scratch to the best of our ability and this seems to be working alright for us. I have heard some horror stories where people have just completely neglected their records which does not sound like fun!

  4. New business owners should always have their first year’s tax return prepared by an accountant. The expense might be a bit higher than new businesses can bear, but making sure that the first year is done correctly will set you up for doing things right yourself in future years. I consider it almost a mandatory expense of the first year of operation.

    1. @Brian, Excellent advice Brian! It may seem like an extra expense but really if you don’t know what you’re doing, you could be leaving money on the table with unclaimed deductions so it could cost you more not to. I would like to add though that you find an accountant who is familiar with home business because not all are. Thanks!

  5. Hi Laura,

    This is such a huge topic and I appreciate your post on the matter. I heard the same advice as Tommy D. above about the home office. I do know someone who did do the home office ‘thing’ and it flagged an audit right away. Keeping really good records and separate accounting is one of the best things to do from the beginning. Thanks again for the post.

    1. @Linnea, Agree. Although it does potentially flag an audit, don’t be afraid to claim what’s rightfully yours by law. Unfortunately, too many do that for fear so it’s important to education yourself and hire someone to do it for you if needed. Thanks Linnea

  7. Hi Laura,

    I really enjoyed your post and it does make total sense.

    Many people take advantage of these tax deductions and many do not. The bottom line is to keep good records.

    My accountant does my taxes and it does make life that much easier.

    As far as the comments above about writing off a room as an office. My accountant advised against it because if you decide to sell your house, your taxing for the house can become very difficult.

    Great information!

    Tommy D.

  8. It is so important to treat your business like a business. Did you know that if you use a spare bedroom for your office, in order to claim a deduction for the room, it has to be primarily used as an office. So you might want to think twice about putting a treadmill in there. (Unless of course the treadmill is where you make your business calls, tee hee)

  9. i used an accountant for 2 years when i started my MLM, and then was comfortable enough to do my own taxes. i highly recommend it! even though it’s cheaper to do it yourself, you get quite an education from a smart accountant that allows you to ask a multitude of questions!

    1. @Melissa McCloud, Hi Melissa, oh yes I most definitely agree. If you’re not familiar enough it’s actually more expensive NOT to utilize the services of an accountant or tax preparer (knowledgeable about home business tax deductions – not all are) because otherwise you could be leaving money on the table AND the expense is also a deductible business expense.

  10. Good info. I think when you decide if you have a business rather than a hobby you’ll treat it better. A hobby can collect dust .. not good for biz.. Thanks Laura!

  11. Hi Laura,

    Thanks for this post. I sit under a different set of rules,in the UK, and this very subject is something I’m checking out at the moment. I have a separate company the equivalent of an LLC but I don’t want to put my home based business under this. I’ll let you know how it pans out.

    Thanks & regards,

    Andrew

    1. @Andrew Sayers, Hi Andrew, I would be interested to know how home businesses are viewed/treated in the UK. I’m only familiar with the U.S.

      Maybe that would make a great, informative blog post once you find out 🙂 Thanks, Laura

  12. Thanks for this information. I often worry about being audited. I do not cheat on my taxes and I am sure what I do is considered a business. I have just heard the IRS likes to audit home businesses.

    Do you have any thoughts on this?

    Thanks

    1. @Rob Franta, Hi Rob. Mostly definitely, home businesses are high up on the list, so it pays to be proactive and make sure you have “all your ducks in a row” BEFORE it happens so that you’re prepared and know what they’ll be looking for.

      Oftentimes when people think of “audit”, they only think in terms of their deductions so the reason for me wanting to point this out. Looking at your deductions and documentation is just one piece of the puzzle and the second piece is the determination of whether or not what we’re doing is a business or a hobby by IRS standards. This is HUGE in terms of what you can/cannot deduct and how.

      The thing to keep in mind is that if it’s not (classified as a business for-profit), they will go back 3 years (or whatever time period is selected) and deny meaning you owe back taxes, interest, etc.

      So, it’s definitely wise to review (objectively) what you’re doing with these 9 factors. And what you believe really doesn’t matter – it’s how what you’re doing meets their criteria.

      Hope this was helpful. Thanks, Laura

  13. neat post Laura it’s true business is business regardless of location and many assume hombased equates to rinky dink and the results or lack of them are a factor of the minset and attitude

    Thanks for sharing Cheers Kiaran

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