Home based businesses are starting to become the norm as a result of the COVID-19 pandemic. And as every business owner knows, their business is subject to taxes. Yet, most small businesses that qualify as home based businesses do not take advantage of a tax break offered by the IRS. Publication 587 permits such small businesses to take advantage of this deduction mentioned above. We explore and simplify this deduction in detail below.
What is a Tax Deduction?
Every business has tax liability. Generally, that tax liability comes from a person’s or business’s income. For purposes of this article, a home based business has the ability to claim a deduction if they can prove the elements of this deduction listed below. If the taxpayer successfully can prove they meet the requirements for this deduction, they will have the ability to lower their tax liability. In other words, the home based business taxpayer can offset expenses they incurred in running their business with income they earned from the business. This in effect reduces the business’s gross income and thereby lowers their income that is subject to tax liability.
For example, let’s say a taxpayer’s business generated revenue and thus has taxable income of $50,000. To set up the business in their home, the taxpayer had to spend $3,000 in expenses. If the taxpayer can meet an allowable deduction offered by the IRS, they can successfully deduct their taxable income to $47,000. Therefore instead of owing tax on $50,000, they now only owe tax on $47,000. While this may seem like a small difference, such tax savings go a long way in keeping money away from the IRS. However, it sounds like this taxpayer will have to prove the deduction offered in Publication 587 for home based businesses. Let’s find out how they can prove such a deduction.
What Do I Need to Show in Order to Meet the Requirements for this Deduction?
To prove this deduction, there are a variety of elements that need to be proved and are directly laid out in the link attached to Publication 587 above. For the purposes of this article, we are focusing on three of the more important elements to prove:
1) Exclusive Use
To show exclusive use, you must be able to prove that a room in your house is exclusively used for the purpose of your business. (NOTE: You can claim this deduction even if you are not working out of your house. The deduction also applies to apartments, condominiums, mobile homes, boats, or anything that provides living accommodations to you).
We must emphasize the exclusivity of this room. For example, if you work out of your living room where your child also plays video games and watches television, you will not be eligible for this deduction. You must exclusively work out of a room solely dedicated to your business.
2) Regular Use
Regular use of the room is also required. Occasional use of the room for your business will not suffice.
3) Trade or Business Use
Finally, you must use it solely for your trade or business. Both this and regular use of the room should be easy to prove as long as the space is regularly used only for trade or business use.
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We understand that many small businesses have been started or moved to the owner’s home because of the pandemic. Thus, we urge you to take advantage of this publication. Contact a tax attorney today to determine if you meet this deduction.